Lecture -1

Multinational Corporation (MNC)

An MNC is a company engaged in producing and selling goods and/or services in more than one
country. It ordinarily consists of a parent company located in the home country and five or six foreign
subsidiaries. Some MNCs have even more than 100 subsidiaries scattered all around the world.

Goal of the MNC

The commonly accepted goal of an MNC is to maximize shareholders wealth i.e. to maximize the
value of the firm.
As MNC managers attempt to maximize their firms value, they may be confronted with various
environmental, regulatory, or ethical constraints.
The Rise of the Multinational Corporation(MNC)
The rise of the MNC can be analyzed from the perspective of
Classical Economy
Modern Economy

The Rise of the Multinational Corporation

Classical Economy
It is based on the doctrine of competitive advantage
Assumptions of this approach
Goods and services can move internationally but
Factors of production such as Land, Labor and Capital are immobile
Modern Economy
Corporation: With the rise of modern communication, transportation and the capability of transfer of
technology, resources etc. the difference among the core nations has been eliminated. As
such, the difference among the corporations is more important than the difference
among the countries.
Homogeneity: Core nations are more homogeneous than before in terms of living standard, life style,
and economic organization. So their factors of production tend to move more
rapidly in search of higher return.
Natural Resources: Natural resources have lost much of their previous role in comparative
specialization because of artificial materials and genetic engineering.
Capital: Now-a-days capital can move freely from one country to another, as such, corporations can
raise capital easily from different financial markets.
Labor: At present, labor skills and wages in many countries can no longer be as fundamentally
different.
Technology: Technologies and know how have become global and people can share information and
knowledge freely.
Reasons of evolution of MNCs
Raw Material Seekers were the earliest multinationals and their aim was to exploit the raw materials
that could be found overseas.
Market Seekers are the modern multinational firms that go overseas to produce and sell in foreign
markets e.g. IBM, Volkswagen, Unilever etc.
Cost Minimizers are the firms that produce in countries where one or more factors of production are
under priced relative to their productivity i.e. Texas Instruments, Atari, etc.
Knowledge Seekers operate in foreign countries to gain knowledge on advanced technology,
operations, or managerial expertise, etc.
Political Safety Seekers acquire or establish new operations in countries that are considered unlikely
to expropriate or interfere with private enterprises.
The process of overseas expansion
International Trade (i.e. exporting and importing) - a relatively conservative approach involving
exporting and/or importing. There is minimum risk in this approach. An MNC can discontinue this
method at low cost and risk if it appears to be unprofitable.
Advantages: minimum capital requirement and start-up costs, low risk, immediate profit, helps in
understanding present and future supply demand condition, market competition,
channels of distribution, payment conventions and financial system etc.

Disadvantages: difficult to realize full potential of a product, less commitment to the local market,
difficult to adjust quickly with the changing market conditions etc.
Licensing - provision of technology (copyrights, patents, trademarks etc.) in exchange for fees or some
other benefits. It allows firms to use their technology in foreign markets without a major
investment in foreign countries and without transportation costs. However, the
disadvantage of this method is that it is difficult sometimes to ensure quality in foreign
production process.
Advantages: minimum investment requirement, faster market entry, less risky etc.
Disadvantages: may create competitors, quality problem, etc.
Franchising - provision of a specialized sales or service strategy, support assistance, and possibly
an initial investment in the franchise in exchange for periodic fees. Like licensing, it
allows firms to enter into foreign markets without a major investment in foreign
countries.
Licensing vs. Franchising
The franchiser maintains a considerable degree of control over the operations and processes used by the
franchisee, however, also helps with things like branding and marketing support that aid the franchise.
On the other hand, the licensing company does not control the business operations of the licensee.
Support and training are provided by the franchiser whereas, these are not provided by the licenser.
Logo and trademark are retained by the franchiser and franchisee is allowed to use those. The licensee
may be allowed to use the logo and trademark of the licenser.
Joint Ventures - joint ownership and operation by two or more firms. Many firms enter in the foreign
markets by engaging in a joint venture with firms that reside in those markets. Most
joint ventures allow firms to apply their respective comparative advantages in a
given project.
Acquisitions of Existing Operations - Firms frequently acquire other firms as means of entering the
foreign markets. Acquisitions allow firms to have full control over their foreign businesses and to
quickly obtain a large portion of foreign market share. However, it involves higher risk as large
investment is required. Besides, if foreign operations do not perform, it may be difficult to sell the
operations at reasonable price. Partial acquisition may happen. Partial acquisition involves less risk and
not full control over foreign subsidiaries.
Establishment of New Foreign Subsidiary Firms can also enter foreign markets by establishing
new subsidiaries to produce and sell products. Like foreign acquisition, it also require a large
investment. Establishment of subsidiary enables a firm to tailor operations as per needs. Besides, there
may be less fund needed to establish subsidiary than to acquire an ongoing business.

The Multinational Financial System

One of the distinguishing characteristics of the MNCs in contrast to domestic firms is the ability to
move money and profit among the subsidiaries through internal transfer mechanisms, which

include the following:

Transfer Price
Intercompany Loans
Dividend and Interest Payments
Lead (speeding up) and Lag (slowing down)
Transfer Price
A transfer price is the price at which divisions of a company transact with each other, such as the trade
of supplies or labor between departments.
If a subsidiary company sells goods to a parent company, the cost of those goods paid by the parent to
the subsidiary is the transfer price.
MNCs have greater control over the mode and timing of these financial transfers.
Mode of Transfer: MNCs have considerable freedom in selecting the financial channels through
which funds or profit or both are moved. They can also vary the amount of profit and fund as per need
by adjusting transfer price and investment flows. MNCs have the flexibility of fixing the rate of
interest, repayment schedule, and choosing the currency of denomination etc.
Timing Flexibility: MNCs have the flexibility of accelerating or delaying the transfer of funds where
there is no fixed schedule of payment exists.
Value: By shifting profits from high-tax to lower tax nations, the MNC can reduce its global tax
payments.
The act of leading and lagging refers to an adjustment in the timing of payment or disbursement to
reflect expectations about future currency movements. For example a US based MNC has subsidiaries
in different countries. One of its subsidiary located in UK purchases some of its supplies from Italy
dominated in lira. If the subsidiary expects that the pound will soon depreciate against the lira, it may
attempt to accelerate the timing of its payment before depreciation of pound. This is known as leading.
If the subsidiary expects the pound to appreciate against the lira, it may try to delay in payment until
the pound appreciates. In this way it will pay fewer pounds for converting to lira. This strategy is
referred to as lagging.
Criticism of MNC
Political Intervention: MNCs some time interfere in the domestic politics, which rises concern among
the local or host government.
Balance of payment imbalance: As MNCs repatriate profits to the home country it may cause balance
of payment imbalance in the host country and ultimately restrictions on fund transfer.
Survival of the domestic companies: MNCs have better technical knowledge, expertise and huge
capital for investment. Moreover, they have high level of efficiency and productivity. All these may
create very competitive situation in the host country and may eliminate domestic firms.
International Challenges
A multinational company faces many factors which a domestic firm does not encounter. These factors
include
exchange and inflation risks

international differences in tax rates

multiple money markets
currency controls and
political risks
International Opportunities
The ability of moving people, money, and material globally, an MNC can increase its value
substantially.
By having operations in different countries, an MNC can access segmented capital markets and can
lower its overall cost of capital.
An MNC can shift profits in order to lower its tax burden
It can take advantage of international diversification of markets and production sites to reduce the
riskiness of its profits
MNCs get better bargaining power and favorable operating conditions when they negotiate
investment agreement with foreign governments.
By operating globally, MNCs get information about the latest technology, research, and
developments of their foreign competitors.
Valuation Model for an MNC
Domestic Model

V a lu e

t=1

F$,

where E (CF$,t ) = expected cash flows to be received at the end of period t

n = the number of periods into the future in which cash flows are received
k = the required rate of return by investors

Valuation Model for an MNC

j 1 E C F

V a lu e =
t=1

j, t

E E R j , t

1 k t

Valuation of International Cash Flows

where E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at
the end of period t
E (ERj,t )= expected exchange rate at which currency j can be converted to dollars at the end of period t

k = the weighted average cost of capital of the U.S. parent company