Chapter 4a: Trading in a multinational

environment
Corporate

strategy in multinational

enterprises
A multinational

enterprise is one which owns or

controls production facilities or subsidiaries or
service facilities outside the country in which it is
based.
Multinational enterprises undertake foreign direct
investment for reasons including obtaining cost and
revenue advantages, tax considerations and process
specialization.
FDI can stimulate economic activity in the host
country, but it can also lead to a loss of political and

Competitive advantages of multinationals

Strategic reasons for engaging in FDI
Market

seeking
Raw material seeking
Production efficiency seeking
Knowledge seeking
Political safety seekers
Economies of scale
Managerial and marketing expertise
Technology
Financial economies

Issues in overseas production decisions

Means

to establish an interest abroad

include:
Joint

ventures
Licensing agreements
Management contracts
Subsidiary
Branches

Issues in overseas production decisions

Destination

countries
Centralised control
Type of integration
Joint ventures
Industrial

co-operation
Joint-equity
Exporting

and licensing
Management contracts
Overseas subsidiaries
Branches (taxation, formalities, marketing)

Theory and practice of international trade

Theory of international trade

Specialization
Main

reason for trade is that there are differences in the

relative efficiency with which different countries can
produce different goods and services

The law of comparative advantage

Countries

should specialize in the goods where they

have a comparative advantage
International trade should be allowed to take place
without restrictions
In practice

Free trade does not always exist

Transport cost may be very high to offset the benefit of
comparative advantage

Advantages of international trade

Surplus to deficit
Competition
Economies of scale
Political advantage

Barriers to entry
Product differentiation barriers
Absolute costs barriers
Economies of scale barriers
Fixed costs
Legal barriers

Trade agreements

Free trade is encouraged within regions of the world

by organisations such as the EU and NAFTA.
However, for multinationals, it is common to
encounter barriers to trade outside these free trade
zones.
Protectionist measures
Tariffs

or customs duties
Import quotas
Embargoes
Hidden export subsidies and import restriction
Deliberately restrictive bureaucratic procedures (red
tape) or product standards
Government action to devalue the domestic currency

Trade agreements

Arguments against protection

Reduced

international trade
Retaliation
Effect on economic growth
Political consequences

Arguments in favor of protection

Imports

of cheap goods
Dumping
Retaliation
Infant industries
Declining industries
Reduction in balance of trade deficit

Optimal tariff argument

Society can gain by restricting imports up

to the point at which the benefit of the last
import equals its cost to society as a
whole. A tariff set to achieve this result is
called an optimal tariff.

Trade agreements and common markets

The European Union

Customs

union
Common market: complete mobility of the factors of
production
Single European currency

The customs union

Free

trade area between member countries

Common external tariff

The single European market

Elimination

of trade restrictions
Remaining barriers

The European Free Trade Area (EFTA)

North American Free Trade Area (NAFTA)

Trade agreements and common markets

A free trade area is where there are no
restrictions on the movement of goods and
services between countries.
A customs union is where there are also
common external tariffs for goods from
non-members.
A common (or single) market further
incorporates the free movement of factors
of production and the achievement of
stronger economic and political links.

The World Trade Organization (WTO)

To support the development of international

trade, the WTO (with over 100 members)
provides a mechanism for:
Reducing

trade barriers
Eliminating discrimination
Preventing the growth of protection
Resolving trade disputes
Establishing rules and guidelines to make world trade
more predictable

Most favored nation

The WTO will impose fines, if members are in
breach of their rules.

International monetary institutions

The

International Monetary Fund

(IMF)
The

IMF aims to:

(a) promote international monetary co-operation

and facilitate international payments
(b) provide support to countries with temporary
balance of payments problems
(c) provide for the orderly growth of international
liquidity, through the Special Drawing Rights (SDR)
scheme

International monetary institutions

IMF

loan conditions

Repaying

the loans fairly quickly

Reduce the demand for goods and services
Deflationary policies are followed

Deflationary policies imposed IM may

damage the profitability of multinationals
subsidiaries by reducing their sales in the
local market

International monetary institutions

The World Bank

This

was created to rebuild Europe after World War 2.

The World Bank provides long-term loans to
government on commercial terms for capital projects.
The major source of funds is borrowing via
commercial bond issues.

The international development association (IDA)

Subsidiary

of the World Bank

Set up to provide soft loans to less developed
countries for similar types of projects financed by the
World Bank

International monetary institutions

The Bank for International Settlements

(BIS)
Profit-making

institution, lends money at

commercial rates
To encourage cooperation between central
banks on matters associated with
international payments.
To provide facilities for financial cooperation
between central banks such as providing
temporary credit for member banks.

International monetary institutions

European

Central Bank
Bank of England
US Federal Reserve System
Bank of Japan

International financial markets and global

financial stability

Rise of global financial markets

buoyed

by the creation of Euro and the

expansion of EU
Rise of China and India

International capital markets and emerging

economies development
Capital

forms

flows to emerging markets take three

Foreign direct investment

Borrowing from international banks
Portfolio investment

International financial markets and global

financial stability
International

capital markets and

financial stability
Financial

contagion
Reduce future crisis in frequency
and intensity
Improved

framework for macroeconomic policy

Improved corporate governance

Developments in world financial markets

Developments
7.1

in world financial markets

The global credit crisis the credit crunch

A credit

crunch is a crisis caused by banks being too

nervous to lend money to customers or to each other
7.1.1 When it all began
7.1.2 What causes the crisis?
Lax lending inflated a huge debt bubble as people
borrowed cheap money and ploughed it into property
If sub-prime borrows had trouble with repayments, rising
house prices would allow them to remortgage their
property
Interest rates increase and house prices fell, borrowers
began to default on mortgage payments

Developments in world financial markets

The

global credit crisis the credit crunch

7.1.3
The

How did it turn into a global crisis?

global crisis stemmed from the way in which debt

was sold into investors
US banking sector packaged sub-prime home loans into
mortgage-backed securities known as collateralised
debt obligations (CDOs). These were sold onto hedge
funds and investment banks
When borrowers began to default on mortgage
payments, the value of these investments plummeted,
leading to huge losses
In the UK, many banks had invested large sums of
money in sub-prime backed investments and have to
write off billions of pounds in losses

Developments in world financial markets

The

global credit crisis the credit crunch

7.1.4
Many

Did IFRS exacerbate the problem?

viewed fair value as aggravating the credit crunch

problem.
As markets collapsed, banks scrambled desperately to
establish values for mortgage-related assets, leading to
huge write-downs and in some cases runs on the bank
As banks mark assets down, their lending capacity is
reduced which affects liquidity. This in turn creates further
uncertainty

Developments in world financial markets

The

global credit crisis the credit crunch

7.1.4

Did IFRS exacerbate the problem?

Market

prices of sub-prime debt are low due to the fact

that no-one is willing to buy, rather than due to the risk
of default. Fair value prices in the current economic
climate are therefore implying a level of default that is
unrealistic
Is it not the threat of write-downs that is the problem
rather than the write-downs themselves?
An article in Accountancy Age on 17 April 2008
suggested that the excessive volatility in the market
was caused not by accounting rules but because
financial statements do not tell banks whose sub-prime
derivatives are better or worse

Developments in world financial markets

The

global credit crisis the credit crunch

7.1.5
As

How were businesses affected

banks confidence low, they stopped lending to each

other, causing a liquidity problem
2008 was characterized by multi-billion dollar government
bail-outs and by the end of the year, US central bank cut
interest rates to 0-0.25%
With low bank lending, business unable to obtain funding
for investments, resulting in large reductions in output and
general business confidence
Workers fear for their jobs and thus reduced spending on
non-essential items

Developments in world financial markets

European Sovereign Debt Crisis
Austerity

measures
Financial contagion
Effect on companies
Where do we go from there

Developments in world financial markets

Traching
How

tranching works

tanche is a slice of a security which is funded

by investors who assume different risk levels
within the liability structure of that security
7.3.2

Example (p.110)
Benefits of tranching
Tranching

Risk

is a good way of dividing risk

of tranching

Tranches

are very complex

Tranches may not be divided properly

Developments in world financial markets

Credit
What

default swaps

are credit default swaps?

The CDS market
Use of CDS speculation
Use of CDS hedging
The role of CDS in the global economic crisis

Developments in world financial markets

Dark

pool trading

is dark pool trading?

What proportion of trading takes place in dark pools?
Problems with dark pool trading
What are regulators doing?
What

Developments in world financial markets

Free movement of capital
Convergence

of financial institution

Todays

financial institutions entry into

various segments of financial services
industries, led to financial conglomerates in
banking, securities and insurance.
The effect is:
Creation

of economics of scale
Creation of economics of scope
Reduction of volatility of earnings
Saving of consumers' significant search costs

Developments in world financial markets

Free

movement of capital

Financial
All

reporting

EU listed company must use IFRS

The reconciliation of IFRS and US GAAP
To increase transparency and comparability
for investors
To lead to a more efficient capital market

Developments in world financial markets

Free

movement of capital

Effect
The

on the corporate sector

raising of capital through global equity and bond

markets has become commonplace and has made
easier cross-border mergers as well as foreign direct
investment
Ongoing integration process of the national stock
exchanges
Primary

issues of European equities has been steadily increasing

with whole new market
A number of Europe-wide equity indices have been established

Alliances

between stock exchanges also foster the

integration of stock market infrastructures and trading
platforms creating more competition and making the
European markets more resilient

Developments in world financial markets

Money

laundering legislation

Money

laundering constitutes any financial

transactions whose purpose is to conceal the
identity of the parties to the transaction or to make
the tracing of the money difficult.
Risks associated with a companys products and
services
The

third Money Laundering Directive of the EU

Financial Services Authority requires that professionals
who engage in the provision of financial services should
warn the authorities when they discover that illegal
transactions have taken place

Developments in world financial markets

Money
The

laundering legislation

effects of regulation

Assessing

risk- the risk-based approach

Assessing you customer base
Customer due diligence
Applying customer due diligence
Ongoing monitoring of your business
Maintaining full and up to date records
The

costs of compliance

Developments in international trade and

Trade and world deflation
finance
comparative

advantages lead to lower cost,

hence form low inflation regime.
E.g. China

Control of monetary policy

Independent

monetary policy

The Bank of England become independent of the

government
The European Central Bank is independent of any
government

A low

inflation environment is conductive to

long-term planning by business and stimulates
investment

Developments in international trade and

Trade zones and international trade
finance

By eliminating trade barriers, the trade zone thus:

facilitates cross-border movement of goods and services

increases investment opportunities
promotes fair competition
enforces intellectual property rights

Trade financing
Commercial

bank loans within the host country and

loans from international lending agencies
Foreign banks be used to discount trade bills to finance
short term financing
Eurodollar financing
Eurobond market
Development banks have been organized in many
countries

Developments in international trade and

Developments in the non market environment
finance
Regulation
Antitrust

actions become non-tariff barriers

In a winner-takes-all situation, MNCs have incentives to
emerge as winner, if not through market process then
through non-market strategy. Thus 'macroeconomic' and
'macro-structural' policies may be used by government

Pressure
Globally

groups

networked pressure group may put pressure on

government to take measures against MNCs

Political
MNCs

risks

need to deal with citizen groups in multiple

countries. They need to integrate their supranational and
multi-domestic non-market strategies