Professional Documents
Culture Documents
euro revenue stream with a forward con- trading. Its goal instead is to minimize its in-
tract. But Markels forecast isnt always cor- ternational currency risks.
rect. Suppose Markel buys a 50,000
contract at $1.05 per euro, or $52,500,
but when the contract is exercised at the SOURCES: Barry Goss and Joost Pennings, Reducing the
Likelihood and Impact of Currency Crises, The Banker,
end of the 90-day period, the euro is actu- January 2010, p. 8; Robert Wade, The Perils of Cross-
ally trading at $1.08. Had Markel esti- Border Payments, World Trade, June 2009, p. 8; Mark
Landler and Simon Romero, Diverging Fortunes, Tied to
mated correctly, it could have made an the Dollar, New York Times, December 11, 2004,
extra $1,500. Like most international firms, retrieved from http://www.nytimes.com; Michael M. Phillips,
How a Small Firm Rides Foreign-Exchange Waves,
however, Markel is not in the business of
Wall Street Journal, February 7, 2003, retrieved from
try- ing to make money on foreign http://www.wsj.com.
exchange
I
nternational financial management is the acquisition and use of funds for cross-border
trade, investment, R&D, manufacturing, marketing, outsourcing, and other com-
mercial activities. It is a complex but critical business function. Firms face many still-
new challenges: increasing globalization, the integration of financial markets, the rise
of global e-commerce, expanding opportunities to profit from financial activities,
and, most recently, the global financial crisis. Financial managers access funds
from in- vestors, foreign bond markets, local stock exchanges, foreign banks,
venture capital firms, and intracorporate financingwherever in the world capital is
cheapest. Their ability to minimize risk and seize opportunities depends on their
financial management skills and their understanding of the laws and regulations
governing financial ex-
changes worldwide.
Financial Centers
The global capital market is concentrated in major financial centers: New York, London,
and Tokyo. Major secondary centers include Frankfurt, Hong Kong, Paris, San Fran-
cisco, Singapore, Sydney, and Zurich. At these locations, firms can access the major
sup- pliers of capital through banks, stock exchanges, and venture capitalists. Exhibit
20.2 lists the share of major financial markets held by Europe, the United States, and
the rest of the world. Europe is home to the largest share of over-the-counter
derivatives turnover (54 percent of the world total), the United States is home to the
largest share of foreign equities turnover, and countries outside Europe and the United
States have size- able market shares in marine insurance and foreign exchange (60
percent and 50 percent, respectively). Europes global share of financial markets has
been rising in recent years, although the United States remains dominant in many
markets.
The global capital market is huge and growing rapidly, despite significant
shrinkage during the recent global financial crisis. In 2009:
International issues of equity in world securities markets amounted to about
$400 billion, up from $83 billion in 1996 and just $14 billion in 1986.
The stock of cross-national bank loans and deposits exceeded $22,000 billion, up
from $11,000 billion 10 years earlier.
There were more than $23,000 billion in outstanding international bonds and
3
notes, up from around $4,000 billion in 1998.
Why did global capital markets grow so rapidly in the past decade? We can count
at least four reasons. First, governments deregulation of financial markets eased move-
ment of capital across national borders. Second, innovation in information and commu-
nication technologies accelerated the ease and speed of global financial transactions.
Third, globalization of business compelled firms to seek new cost-effective ways to fi-
nance global operations and conduct financial management activities. Fourth is the
Chapter27 20 Financial Management and Accounting in the GlobalTask Two: Raise Funds for the Firms International Activities
Firm 27
Fund management
0 20 40 60 80
Percentage share of world markets (2009) Europe United States Rest of world
Exhibit 20.2 Share of Financial Markets in Major World Regions
SOURCE: International Financial Markets in the UK, November 2009. International Financial Services London. Accessed at http://www.ifsl.org.uk.
Equity Financing In equity financing, the firm obtains capital by selling stock,
which gives shareholders a percentage of ownership in the firm and, often, a stream of
dividend payments. The main advantage is that the firm obtains capital without debt.
Chapter28 20 Financial Management and Accounting in the GlobalTask Two: Raise Funds for the Firms International Activities
Firm 28
However, whenever new equity is sold, the firms ownership is diluted. Management
also risks losing control in the event one or more shareholders acquire a controlling
Global equity market interest. Internationally, firms obtain equity financing in the global equity market
The worldwide market of stock exchanges worldwide where investors and firms meet to buy and sell shares of
funds for equity financing stock. Exhibit 20.3 lists the largest stock exchanges in the world. Note the dominance
stock exchanges around the of exchanges in Britain, Germany, Japan, and the United States. NASDAQ OMX
world where investors and (www.nasdaq.com) and NYSE Euronext (U.S.; www.nyse.com) are the largest in
firms meet to buy and sell terms of volume of shares traded ($29 trillion and $17.8 trillion in 2009, respectively).
shares of stock. Among the roughly 3,200 firms listed in NYSE Euronext, about 500 are foreign-owned
firms from Europe, Canada, Asia, and Latin America.
As an investor, you are not limited to buying equity in firms listed in the stock ex-
changes of your home country. Many investors today buy stocks on foreign exchanges,
5
a trend driven by the large-scale activities of institutional investors. Investing on for-
eign exchanges makes sense for two main reasons. First, they provide new opportuni-
ties for lucrative investing. Second, investing internationally can help minimize losses
during slumps in the local economy. For example, U.S. investors can buy stock from
among several hundred companies listed on the London exchange, including King-
6
fisher, Canon, and South African Breweries.
Pension funds, which invest employee savings for retirement, represent the largest
segment of international investing. In 2009, total private pension assets invested in Or-
ganisation for Economic Co-operation and Development countries (OECD, a group of
thirty leading advanced economies and emerging markets; www.oecd.org) were
around
Shanghai SE
Tokyo SE
London SE
Shenzhen SE
Deutsche Brse
Korea Exchange
0 5 10 15 20 25 30
Debt Financing
In debt financing, a firm borrows money from a creditor (or sells bonds) in exchange
for repayment of principal and an agreed-upon interest amount in the future. The main
ad- vantage is that the firm does not sacrifice any ownership to obtain needed capital.
M
any investors view stocks in on the Shanghai and Shenzhen ex-
also have experienced
emerging markets as a good changes have been volatile.
con- siderable
bet because of the forma- During the most recent global fi-
volatility. Share-price
tion there of numerous fast-growth nancial crisis, industrial production and
indices
firms. While some political regimes exports declined in numerous emerging
do not consistently respect share- markets, leading to cur- rency
holder rights and the rule of law, devaluation as well. Investment flows
their economies often are geared for declined significantly as banks reduced
global growth. cross-border loans and equity portfolio
Emerging-market stocks often investors withdrew funds from the
entail considerable risk. Investors markets. As the panic began to subside in
were burned by the Asian financial cri- 2009, investors reevalu- ated their
sis in 1997, when countries such as positions and positive growth returned
Thailand and Malaysia saw their cur- to exchanges in many emerging
rencies devalued because local banks markets.
could not service their debt obliga- As opportunities arise in emerg- ing
tions. Shockwaves prompted a sell- markets to invest in stock markets and
off in stock markets in various undertake FDI, firms and govern- ments
countries due to the cross-national there understand the cost of capital goes
intercon- nectedness of financial hand in hand with good governance and
markets. respect for share- holder rights. Firms
In 1998, the Russian government that abuse share- holders by not
devalued its currency and defaulted providing periodic earnings reports find
on its debt. Equity markets in it hard to raise money from the public.
To accommodate demand to in- vest in
emerging markets, local stock exchanges are
becoming increas- ingly sophisticated. Those
in Brazil and China have several hundred cor-
porate listings, worth hundreds of bil- lions of
dollars. In smaller countries, the stock
exchange may be a one- room operation
with a blackboard and a telephone. Bhutan,
Oman, and Kazakhstan have established primi-
tive exchanges in the hope of be- coming
the next Chile or Singapore.
Intracorporate Financing
Funding for international operations can also be obtained from within the firms net-
work of subsidiaries and affiliates. At times, when some units of an MNE are cash-rich
and others are cash-poor, they can lend each other money. Intracorporate financing is Intracorporate
funds from sources inside the firm (both headquarters and subsidiaries) in the form of financing Funds from
equity, loans, and trade credits. Trade credit arises in the firm when a supplier unit sources inside the firm
grants a buyer unit the option to pay at a later date. (both headquarters and
What are some advantages of loaning funds to the firms own foreign subsidiaries? subsidiaries) such as equity,
First, it can reduce the borrowing subsidiarys income tax burden because interest pay- loans, and trade credits.
ments are often tax deductible. Second, an intracorporate loan has little effect on the
par- ents balance sheet, because the funds are simply transferred from one area of the
firm to another. Third, a loan within the MNE may save bank transaction costs (fees
banks charge to exchange foreign currencies and transfer funds between locations).
Fourth, a loan avoids the ownership dilution of equity financing.
IBMs global financing division invests in international financing assets and obtains
and manages international debt to support IBMs global operations. The division pro-
vides loan financing to internal users for terms of two to five years. It p rovides inven-
tory and accounts receivable financing to IBMs dealers and subsidiaries in various
12
countries.
remits dividends;
pays royalties
sets low transfer price
Taiwanese Mexican
Subsidiary Subsidiary
provides loan;
extends credit on purchases
Multilateral Netting
In the past, cash was frequently held in each foreign subsidiary responsible for funding
its own short-term needs. Today, MNE managers use a method known as pooling to
bring surplus funds together in a regional or global centralized depository. They then
direct these funds to needy subsidiaries or invest them to generate income.
A centralized depository lets managers reduce the size of highly liquid accounts
and invest the funds, generally at the higher interest rates offered for large deposits, to
gen- erate maximal returns. If the depository is in a financial center (London, New York,
Sydney, or Toronto), management can also access a variety of short-term investments
that pay higher rates of return. Finally, the depository centralizes expertise and
financial services, providing subsidiaries with more benefits at lower cost.
Large MNEs conduct numerous international transactions, each of which generates
transaction costs. Suppose a firms Japanese subsidiary owes the Spanish subsidiary
$8 million and the Spanish subsidiary owes the Japanese subsidiary $5 million. While
Multilateral netting the firm could cancel these debts in separate transactions, a more intelligent solution
Strategic reduction of cash that reduces transaction costs has the Japanese subsidiary pay the Spanish subsidiary
transfers within the MNE $3 mil- lion. Transferring an amount considerably lower than either of the two original
family through the amounts greatly reduces transactions costs such as fees and delays in funds transfers.
elimination of offsetting At a more sophisticated level, multilateral netting is the strategic reduction of cash
cash flows. transfers within the MNE family through the elimination of offsetting cash flows
involv- ing three or more subsidiaries that hold accounts payable or accounts receivable
with an-
Chapter33 20 Financial Management and Accounting in the Global Firm Task Four: Perform Capital Budgeting 33
other subsidiary. MNEs with numerous subsidiaries usually establish a netting center,
a central exchange, that headquarters supervises. Philips, a leading Dutch consumer
elec- tronics firm (www.philips.com), has operating units in some sixty countries and a
net- ting center to which subsidiaries regularly report all intracorporate balances on the
same date. The center then advises each subsidiary of the amounts to pay and receive
from other subsidiaries on a specified date, helping save Philips considerable money.
Chip Besse
C
hip Besse is a natural entrepre- worked with a team that closed deals for an Eastern European startup, also
neur who started a waste man- throughout Europe and the Middle in the waste management business,
agement company while in East, accumulating experience as he and a $600 million acquisition of a
college. He realized early that he assisted in soliciting funds from eq- European sporting firm. In his spare
wanted a career in finance, so in his uity investors and banks, and he time, Chip obtained certification in
junior year he obtained a 10-month made presentations to credit com- advanced financial modeling, corpo-
internship with Merrill Lynch, the in- mittees and transaction manage- rate valuations, and analysis of finan-
vestment broker, where he assisted ment teams. He also researched cial statements.
with quarterly reports on restructur- financial data on acquisition targets
ing client portfolios. Chip studied on in various sectors and devised a sys-
his own and became well versed in in- tem for monitoring budget
Success Factors for a
surance sales and variable invest- variances on ongoing investments. Career in
ment annuities. Chips group acquired underper- International Business
In his senior year, Chip studied in forming firms and restructured their I enjoy learning about new cultures
Valencia, Spain. The experience strategies to make them leading in- and assessing investment opportuni-
opened his eyes to the possibilities of dustry players. To refocus a family- ties where the common variables
an international career. A campus run Scandinavian firm that was losing change drastically. My work
visit from an international bank money, Chip and his group cut costs requires an eclectic skill base. We
executive motivated Chip further. He and devised new growth strategies. often deal with political risk,
contacted the banker via e-mail and Through the teams efforts, the firm currency risk, and cultural risk. We try
telephone for several months until, brought in proceeds from divestment to mitigate most of the risks by doing
impressed by his persistence, she of nearly $150 million and increased our homework, talk- ing to local
offered him an in- ternship at the its profit margin from 2 to 9 percent. people, immersing our- selves in the
large international bank where she In Britain, Chip worked on the culture, and being really diligent by
worked in London. LBO visiting all the locations. There is no
Chips hard work so impressed of a movie-theatre chain worth over normal day at the office.
his superiors that they enrolled him in $800 million. His assignments in-
the banks Graduate Training Pro- cluded financial modeling of the ac-
gram, where he learned how to build quisition, refinancing, and optimizing Challenges
financial models for managed buy- the firms capital structure. Chip I recommend a career in interna-
outs (MBOs) and leveraged buy-outs nego- tiated with lawyers, tional business even though doing
(LBOs), as well as mergers and acqui- accountants, and trade partners. In business in another country and liv-
sitions. Chips work involved him in Central America, he negotiated an ing away from your family and friends
deals to buy companies, make them LBO for a solid-waste removal firm. is not easy. It takes an open mind,
more profitable, then sell them. He He worked on a $30 mil- lion debt and much hard work, and persistence.
equity fund-raising deal
vestments. Exchange rate fluctuations help or hurt sales by making the firms products
relatively more or less expensive for foreign buyers. If the yen appreciates against the
euro, a European firm can expect to sell more goods in Japan because the Japanese
have more buying power for buying euros. But if the yen weakens against the euro, the
Euro- pean firms sales will likely drop in Japan unless management lowers its
Japanese prices by an amount equivalent to the fall in the yen. Similarly, the firm
may be harmed by
547
Chapter36 20 Financial Management and Accounting in the Global Firm
currency shifts that raise the price of inputs sourced from abroad. The value of foreign
investments can also fall, in home currency terms, with exchange rate changes.
While transaction exposure is a factor in ongoing contractual transactions,
economic exposure affects long-term profitability through changes in revenues and
expenses and thus appears in the firms financial statements. For example, weakening
of the U.S. dol- lar against the euro gradually reduces the value of U.S. investments in
Europe, increases the cost of Euro-denominated input goods, but improves the
prospects for U.S. firms to sell their dollar-denominated products in the EU.
The three types of currency exposure can produce positive results when exchange
rates fluctuate favorably for the firm. Managers are more concerned with fluctuations
that harm the firm. Such problems help explain why many countries in Europe use a
sin- gle currency, the euro. With a single medium of exchange, currency risk is
eliminated in trade among the countries using the euro. For international firms
operating outside the euro zone, however, currency risk is still a significant problem.
Types of Currency
Forward rate The
Traders exchange rate applicable to
The three main types of currency traders are hedgers, speculators, and arbitragers. the collection or delivery of
Hedgers, typically MNEs and other international trade or investment firms, seek to a foreign currency at some
min- imize their risk of exchange rate fluctuations, often by entering into forward future date.
contracts or similar financial instruments. They are not necessarily interested in Direct quote The
profiting from cur- rency trading. number of units of domestic
Speculators are currency traders who seek profits by investing in currencies with currency needed to acquire
the expectation their value will rise in the future and then sell them later at the higher one unit of foreign
value. A speculator might purchase a certificate of deposit denominated in Mexican pe- currency; also known as the
sos or a money market account tied to the Chinese yuan, believing the value of these normal quote.
cur- rencies will rise. The speculator can also bet on a currencys downturn by taking a
Indirect quote The
short position in that currency. When investors take a short position, they sell a currency
number of units of foreign
that they previously borrowed from a third party (usually a broker) with the intention
currency obtained for one
of buying the identical currency back at a later date to return to the lender. In so doing,
unit of domestic currency.
the short seller hopes to profit from a decline in the value of the currency between the
sale and the repurchase, as the seller will pay less to buy the currency than the seller Hedgers Currency
received on selling it. Exhibit 20.5 shows an example speculation in the foreign traders who seek to
exchange market through a forward contract. minimize their risk of
Arbitragers are currency traders who buy and sell the same currency in two or exchange rate fluctuations,
more foreign-exchange markets to profit from differences in the currencys exchange often by entering into
rate. But unlike the speculator who bets on the future price of a currency, the arbitrager forward contracts or similar
attempts to profit from a current disequilibrium in currency markets based on known financial instruments.
prices. If the euro-dollar exchange rate quoted in New York on Monday morning is 1 Speculators Currency
$1.25, but the quoted exchange rate in London at that moment is 1 $1.30, a trader traders who seek profits by
could buy investing in currencies with
1 million for $1.25 million in New York and simultaneously sell those euros in the expectation their value
London for $1.3 million, yielding a riskless profit of $50,000 before commission and will change in the future.
expenses. But dont get too excited! When such arbitrage opportunities exist, they
quickly disap- pear because the very actions of the arbitragers force the exchange rates
to adjust to the equilibrium level.
Chapter38 20 Financial Management and Accounting in the Global Firm Task Five: Manage Currency Risk 38
Exhibit 20.5 An Scenario: A speculator is offered a forward contract by a bank to be able to sell the bank 1 in
Example of Speculation exchange for $1.45 one year from now. Suppose that the speculator expects the spot
exchange rate to be 1 $1.40 a year from now. The speculator may try to profit from the
in the Foreign Exchange difference between the expected spot exchange rate and the quoted forward exchange rate by
Market entering into a forward contract with the offering bank. In this case, the speculator is taking a
risk by attempting to make a profit based on an uncertain future spot exchange rate.
Speculator receives
from the bank $1.45
Speculator buys 1 through the forward contract
in the spot market
Outcome: If the spot exchange rate is actually 1 = $1.40 a year from now, the speculator earns a
profit of $0.05. However, if the spot exchange rate turns out to be 1 = $1.50, the speculator will
lose $0.05 as a result of having to sell the bank, through the forward contract, 1 for $1.45
instead of its actual spot value of $1.50.
Hedging Instruments Having assessed its level of currency risk exposure, the firm
attempts to balance exposed assets and exposed liabilities. The four most common
hedging instruments are forward contracts, futures contracts, currency options, and
currency swaps. Forward contract A
A forward contract is an agreement to exchange two currencies at a specified ex- contract to exchange two
change rate on a set future date. No money changes hands until the delivery date of the currencies at a specified
contract. Banks quote forward prices in the same way as spot priceswith bid and ask exchange rate on a set
prices at which they will buy or sell currencies. The banks bid-ask spread is a cost for future date.
its customers.
Forward contracts are especially appropriate for hedging transaction exposure.
Sup- pose Dow Chemical (www.dow.com) sells merchandise to a German
importer for
100,000, payable in 90 days. During the 90 days, Dow has a transaction exposure to
cur- rency risk: It will receive fewer dollars if the euro depreciates during that time. To
hedge against this risk, Dow executes a forward contract with a bank to sell 100,000 in
90 days at an exchange rate agreed upon today, ensuring it receives a known dollar
amount in the future. Exhibit 20.6 illustrates the cash flows of Dow Chemicals forward Futures contract
market hedge. An agreement to buy or sell
Like a forward contract, a futures contract represents an agreement to buy or sell a a currency in exchange for
currency in exchange for another at a specified price on a specified date. Unlike forward another at a specified price
contracts, futures contracts are standardized to enable trading in organized exchanges, on a specified date.
such as the Chicago Mercantile Exchange. While the terms of forward contracts are
nego- tiated between a bank and its customer, futures contracts have standardized Currency option
maturity pe- riods and amounts. Futures contracts are especially useful for hedging A contract that gives the
transaction exposure. purchaser the right, but not
A currency option differs from forward and futures contracts in that it gives the the obligation, to buy a
pur- chaser the right, but not the obligation, to buy a certain amount of foreign certain amount of foreign
currency at a set exchange rate within a specified amount of time. The seller of the currency at a set exchange
option must sell the currency at the buyer s discretion, at the price originally set. rate within a specified
Currency options typi- cally are traded on organized exchanges, such as the London amount of time.
Stock Exchange (www
.londonstockexchange.com) and the Philadelphia Stock Exchange (PHLX; www
25
.nasdaqtrader.com), and only for the major currencies.
Scenario: Dow Chemical sells merchandise to a German importer for 100,000, payable in 90 days.
Given that the U.S. dollar - euro spot exchange rate 90 days from now is not known today, Dow faces
uncertainty regarding how much it will be receiving from its German customer in U.S. dollar terms.
To hedge against this risk, Dow enters into a forward contract with a bank to sell 100,000 90 days
from now at an exchange rate of 1 $1.45 agreed upon today, ensuring that it receives a known
dollar amount in future.
Dow receives from the bank
Dow receives 100,000 $145,000
from its customer
Outcome: Today, Dow is able to see that the 100,000 it will be receiving from its
European customer will be worth $145,000 regardless of how much the actual spot price of
the euro is 90 days from now.
There are two types of options. A call option is the right, but not the obligation, to
buy a currency at a specified price within a specific period (called an American option)
26
or on a specific date (called a European option). A put option is the right to sell the
currency at a specified price. Each option is for a specific amount of currency. On a
recent date, Australian dollar option contracts were offered with a contract size of
50,000 Australian dollars on the NASDAQ OMX PHLX. Options are useful as an
insurance policy or dis- aster hedge against adverse currency movements.
Currency swap In a currency swap, two parties agree to exchange a given amount of one currency
An agreement to exchange for another and, after a specified period of time, give back the original amounts. Thus,
one currency for another, a swap is a simultaneous spot and forward transaction. When the agreement is
according to a specified activated, the parties exchange principals at the current spot rate. Usually each party
schedule. must pay in- terest on the principal as well. If Party A loaned dollars and borrowed
euros, it pays in- terest in euros and receives interest in dollars. Consider the following
example: An MNE agrees to pay 4 percent compounded annually on a euro principal
of 1,000,000 and re- ceive 5 percent compounded annually on a U.S. dollar principal of
$1,300,000 every year for two years. As a result it will receive 1,000,000 and pay
$1,300,000 today. It will then pay 40,000 annual interest and receive $65,000 annual
interest for 2 years. At the end of the second year, the MNE will receive $1,300,000 and
pay 1,000,000.
International Taxation
In the countries where they operate, companies pay direct taxes, indirect taxes, sales
taxes, and value-added taxes, among others. Direct taxes are typically imposed on
income from profits, capital gains, intracorporate transactions, royalties, interest, and
dividends. Indirect taxes apply to firms that license or franchise products and services or
that charge interest. In effect, the local government withholds some percentage of
royalty payments or interest charges as tax. A sales tax is a flat percentage tax on the
value of goods or ser- vices sold, paid by the ultimate user. A value-added tax (VAT) is
payable at each stage of processing in the value chain of a product or service. VAT is
calculated as a percentage of the difference between the sale and purchase price of a
product and is common in Canada, Europe, and Latin America. Each business in a
products value chain is required to bill the VAT to its customers and pay the tax on its
purchases, crediting the amounts it
556 Chapter 20 Financial Management and Accounting in the Global Firm
Exhibit 20.8
Corporate Income Tax Rates Argentina
Around the World (as a
Australia
percent of corporate
Tax in 2001
income, rounded to the Belgium
Tax in 2008
nearest whole percent) Brazil
SOURCE: Information reprinted from
KPMG International. KPMG is a Swiss Canada
cooperative. Member firms of the KPMG
network of independent firms are affiliated
with KPMG International. KPMG China
International provides no client services.
No member firm has any authority to France
obligate or bind KPMG International or any
member from vis-a-vis third parties, nor
does KPMG International have any such Germany
authority to obligate or bind any member
firm. All rights reserved. Reprinted with India
permission of KPMG International.
Indonesia
Ireland
Italy
Japan
Mexico
Netherlands
New Zealand
Russia
South Korea
Spain
Sweden
Turkey
United Kingdom
United States
0 10 20 30 40 50
paid against the amounts due on its own activities. The net result is a tax on the added
value of the good.
The most common form of direct tax is the corporate income tax. Exhibit 20.8
provides rates for a sample of countries. Called corporation tax in some localities, it
is a major factor in international planning because it encourages managers to organize
business operations in ways that minimize the tax, usually by deducting business
expenses from revenues. Thus, income tax influences the timing, magnitude, and
composition of com- pany investment in plant and equipment, R&D, inventories, and
other assets. The ex- hibit reveals that many countries have reduced tax rates because
31
they recognize high taxes can discourage investment. In Russia, the corporate
income tax rate decreased from 43 percent in 2001 to 24 percent in 2008. In Canada, the
rate decreased from 42 per- cent to 36 percent. Ireland has the lowest income tax rate,
13 percentone of the pillars of its economic revitalization policy.
The U.S. automaker Ford has sold cars in Canada, Japan, and several other
countries almost since its founding in 1903. At one time, whenever Ford sold cars in
Canada, it was required to pay direct taxes on its income in both Canada and the
32
United States. Be- cause of a lack of harmony in international tax rules, many MNEs
were subject to dou-
Task Six: Manage the Diversity of International Accounting and Tax Practices 45
ble taxation, which reduced company earnings and discouraged firms from investing
abroad. To resolve the problem, most countries signed tax treaties with their trading
partners that help ensure firms pay an appropriate amount of tax. A typical tax treaty
be- tween country A and country B states that, if the firm pays income tax in A, it need
not pay the tax in B (or vice versa) if the taxes are similar amounts. This result is accom-
plished with foreign tax creditsan automatic reduction in domestic tax liability when
the firm can prove it has already paid income tax abroad. Or the firm may be liable to
pay tax in each country, but the amount is prorated so the total is no more than the
max- imum tax in either country. Most tax treaties also obligate nations to assist each
other in tax enforcement, ensuring that MNEs pay taxes in one country or the other to
deter tax evasion.
Tax Havens Because tax systems vary around the world, MNEs have an incentive to
structure their global activities in ways that minimize taxes. They take advantage of tax
havens like the Bahamas, Luxembourg, Singapore, and Switzerland, either by
establishing operations in them or by funneling business transactions through them.
Nissan and Kraft Foods moved their European headquarters to Switzerland to take
advantage of lower corporate taxes. The Irish rock bank U2 moved its music-publishing
33
business to the Netherlands to shelter its songwriting royalties from taxation. The use
of tax havens for tax reduction is generally legal but is restricted by some governments.
34
The United States limited firms ability to move major operations to such countries.
Corporations sometimes use tax havens to park revenues until needed elsewhere for
trade or investment.
The OECD, World Bank, and other international organizations discourage the
wrongful use of tax havens and lobby countries to develop transparent tax systems.
The EU and OECD also pressure countries to reduce harmful tax competition. In
Europe, foreign investors tend to establish operations in countries with low taxes and
avoid countries with high taxes. Because this discourages European unity and
economic de- velopment, EU governments are seeking to harmonize taxation
throughout Europe.
558
Closing Case 559
fers. Management also matches hedging instruments need for local borrowing. The centralized approach also
with the firms most pressing currency exposures. The concentrates managerial expertise and financial services
launch of the euro greatly simplified international trans- at one location. Finally, the firm employs a reinvoicing
actions and reduced the need for some netting opera- center that invoices foreign subsidiaries in the local cur-
tions in Europe. rency but receives invoices in U.S. dollars.
Case Questions
1. What are the implications for currency risk of TEK fo- recommend to reduce the firms exposure even fur-
cusing its manufacturing in the United States but ther? Justify your answer.
generating most of its sales abroad? Competitors 3. TEK management attempts to maintain a
like HP and Kodak are more geographically diversi- reasonable ratio of debt to equity. Most firms
fied in their sourcing. What advantages does this prefer relatively low levels of debt in their capital
create for them? structures. Why? What other approaches could
2. The case lists various approaches TEK follows to TEK use to generate financing for its international
minimize its exposure to currency risk. If hired by operations? What ap- proaches can TEK use to
TEK, what other strategies and tactics would you transfer funds within its op- erations worldwide?
Chapter48 20 Financial Management and Accounting in the Global Firm Chapter Essentials 48
4. The case describes approaches TEK follows to mini- World, April 8, 2006, pp. 4245; Lori Ioannou, Taxing Issues, International Busi-
ness, March 1995, pp. 4245; Marshall Lee, Winning with People: The First 40
mize its international tax liability. Based on your Years of Tektronix (Beaverton, OR: Tektronix, Inc., 1986); Richard J. Maturi, Take
reading of the chapter, how would you advise TEK the Sting Out of the Swings, Industry Week, September 3, 1990, p. 96; Tim
McElligott, This Way Out: Rick Wills, Tektronix, Telephony, June 4, 2001, pp. 190
management to further reduce its taxes around the 191; Arthur Stonehill, Jerry Davies, Randahl Finnessy, and Michael Moffett, Tektronix
world? (C), Thun- derbird International Business Review 46, no. 4 (July/August 2004):
465469; Sony Corp., History of Sony, retrieved from http://www.sony.net;
Tektronix, Inc., Tektronix Named Finalist for Best in Test 2010 Awards, press
SOURCES: Tektronix Finds Surprising Results from Net Promoter Scores, B to B, release re- trieved from http://www.tek.com; Tektronix corporate profile
June 9, 2008, p. 14; Danaher to Acquire Tektronix, Canadian Electronics, retrieved from http://www.hoovers.com; Tektronix corporate Web site at
November/December 2007, p. 1; Danaher, Inc., 2008 Annual Report, Washing- http://www.tek.com; Tektronix, Inc., 2000 Annual Report and Form 10-K to U.S.
ton, DC; Joseph Epstein, Did Rip Van Winkle Really Lift Its Head? Financial Securities and Ex- change Commission (2005), Beaverton, OR.
CHAPTER ESSENTIALS
Key Terms
arbitragers, p. 550 Eurodollars, p. 542 foreign hedging, p. 551 indirect quote,
bond, p. 542 bond, p. 542 forward p. 549 intracorporate financing,
consolidation, p. 546 contract, p. 551 forward p. 543 multilateral netting, p.
currency option, p. 551 rate, p. 549 fronting loan, 544 speculators, p. 549
currency swap, p. 552 p. 544 futures contract, p. spot rate, p. 548 tax
current rate method, p. 555 551 global bond market, p. haven, p. 544 temporal
debt financing, p. 537 542 method, p. 555
direct quote, p. 549 global capital market, p. 538 transaction exposure, p. 546
economic exposure, p. 546 global equity market, p. 540 translation exposure, p. 546
equity financing, p. 537 global money market, p. 538 transparency, p. 553
Eurobond, p. 542 hedgers, p. 549
Eurocurrency, p. 542
Summary
In this chapter, you learned about:
1. Key tasks in international financial kets and by retaining earnings. Debt financing is
management ob- tained by borrowing money from banks and
International financial management involves the acqui- other fi- nancial institutions or by selling bonds.
sition and use of funds for cross-border trade and
in- vestment activities. Participants include firms, 3. Raising funds for the firms international
banks, and brokerage houses. Managers such as activities
Chief Fi- nancial Officers (CFOs) organize financial Companies can raise money in the global capital
activities inside the focal firm. CFOs decide on the market. Equity financing can be obtained in the
firms cap- ital structure, raise capital, manage global equity marketthe stock exchanges
working capital and cash flows, do capital through- out the world where investors and firms
budgeting, manage cur- rency risk, and deal with meet to buy and sell shares of stock. In terms of debt
diverse accounting and tax practices. financing, firms may borrow in the Eurocurrency
market, which uses currency banked outside its
2. International capital structure country of origin. Firms also sell bondsoften
The capital structure is the mix of long-term foreign bonds or Eurobondsin the global bond
financing equity financing and debt financing market. In addition, MNEs can support the
that the firm uses to support its international operations of their sub- sidiaries through
activities. Equity fi- nancing is obtained by selling intracorporate financing.
shares in stock mar-
4. Management of working capital and cash statements, a process called consolidation.
flow Currency trading takes place between banks and
Net working capital is the difference between current currency bro- kers, often on behalf of multinational
assets and current liabilities. Firms often manage firms. Cur- rency traders include hedgers,
in- tracorporate funds by developing a centralized speculators, and arbitragers. Managers attempt to
depos- itory, into which funds are pooled from the forecast exchange rates to minimize their firms
firms network of subsidiaries and affiliates to exposure to currency risk. Approaches for
distribute to units that need funds. The various minimizing exposure to currency risk include
methods for transferring funds within the MNE centralizing currency management, measuring
include dividend remittances, royalty payments, currency risk, monitoring long-term trends, and
transfer pricing, and fronting loans. A fronting loan is emphasizing flexibility in international operations.
a loan from a parent firm to its subsidiary, Firms also employ hedging, the use of specialized
channeled through a bank or other financial financial instruments to balance posi- tions in
intermediary. Multilateral netting is the process of foreign currencies. Key hedging tools in- clude
strategically reducing the number of cash transfers forward contracts, futures contracts, currency
between the parent and subsidiaries by eliminating options, and currency swaps.
the offsetting cash flows between these entities.
7. Management of international accounting
5. Capital budgeting for international operations and tax practices
Capital budgeting rests on analyses that management Financial statements prepared in one country may
undertakes to evaluate the viability of proposed in- be difficult to compare with those from other coun-
ternational projects. Management calculates the net tries. Through transparency, firms regularly and
present value of a proposed project to decide comprehensively reveal reliable information about
whether it should be implemented. their financial condition and accounting practices.
Various factors account for differences in national
6. Management of currency risk accounting systems. Several international organiza-
There are three main types of currency exposure: tions are aiming to harmonize cross-national ac-
transaction exposure, economic exposure, and counting practices. Managers use the current rate
trans- lation exposure. A firm faces transaction method and the temporal method for currency
exposure when outstanding accounts receivable or translation. Internationally, firms seek to minimize
payable are denominated in foreign currencies. taxes, which consist of direct taxes, indirect taxes,
Economic expo- sure results from exchange rate sales taxes, and value-added taxes. Governments
fluctuations affecting the pricing of products, the use two major methods for eliminating multiple
cost of inputs, and the value of foreign investments. tax- ation: the foreign tax credit and tax treaties.
Translation exposure arises as the firm combines Tax havens are countries with low taxes that are
the financial statements of foreign subsidiaries friendly to business and inward investment.
into the parents financial
3. From a managerial perspective, what are the advan- 6. What are the major steps in capital budgeting? For
tages and disadvantages of financing obtained from what types of ventures do international managers
each of the following: equity, debt, and typically engage in capital budgeting?
intracorporate sources?
7. What are the types of currency exposure? Why is
4. Suppose you had to raise capital to fund interna- currency exposure potentially harmful to the firms
tional value-adding activities and investment proj-
development of, 35 intellectual property protection, 444 subsidies, 211
Doha Round collapse, 217 market data sources, 351e
dumping, 212 overview, 4, 185
formation of, 33 regional economic integration, 229 Y