Chapter 1

Introduction

McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
A.

B.
C.

D.

E.

Explain globalization and discuss Factors. Discuss theories of trade. Distinguish. Discuss how MNCs facilitate globalization and special risks faced by them. Compare US and other governance models. List international financial management issues.
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A1. What is Globalization?

Movement of Goods: worldwide integration of producers and consumers Movement of Services: cross-border flow of services (e.g., tourism, consulting) Movement of People: migration toward work Movement of Money: investments across borders

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A2. Factors Influencing Globalization

End of World War II: unprecedented era of peace helped the global economy Trade Agreements: WTO, NAFTA, etc. Dismantling of Socialist Systems: liberation of E. Europe Rise of Asia: China, India and other economic power

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A3. Technology, Innovation & Globalization

Telecommunications Revolution: allows low-cost contact and spurs business activity Internet: a post-1980 phenomenon, radically transforms ability of parties to conduct business across borders (e.g., outsourcing) Sea and Air Shipping: containerization and other innovations brought down cost

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B1. Trade: Classical Theory

Theory of comparative advantage (David Ricardo, 19th century)

Labor productivity differs within country and across countries because of varying technology Nations have relative advantages in certain products (e.g., Portugal had advantage in wine and England had advantage in cloth) Countries benefit by shifting production and making products where they have an advantage and by trading with other countries (e.g., Portugal produces more wine and England produces more cloth)

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B2. Trade: Neoclassical Theory

Heckscher and Ohlin (HO) model:

Focus on factor abundance, rather than technology, as explanation for productivity differences Countries with relatively more capital will focus on capital intensive industries (e.g., automobile, steel) Countries with relatively more labor will focus on labor intensive industries (e.g., textiles, agriculture)

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B3. Other Theories of Trade

Imperfect Markets: Factors of production (e.g., labor, capital) cannot easily move across borders, so countries specialize using what they have. Gravity: More trade occurs between countries of similar size and of close proximity Firm-level Product Cycle: Over time, to increase scale, firms export New Trade: Consumers seek variety and producers seek scale. This theory is unique is explaining why a country may simultaneously import and export the same product

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B4. Location Theories

Industry Agglomeration: Positive externalities such as knowledge spillover, labor market pooling and development of ancillaries help agglomerate an industry in one location (e.g., computer industry in Silicon Valley) Porters Diamond: Explains why nations have advantage in certain products:

Factor conditions Demand conditions Related and Supporting Industries Firm Strategy, Structure and Rivalry

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C1. Why Firms Become MNCs?

OLI model:
Ownership Advantages: firm has specialized assets Location Advantages: input availability, low taxes, etc. Internalization Advantages: in-sourcing more advantageous than outsourcing

Knowledge-Capital model:
Knowledge capital can be transferred crossborder much easier than physical capital (foreign subsidiaries can be created easily) Skilled labor is important, usually abundant in the home country of MNC

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C2. MNCs Facilitate Globalization

MNCs are skilled in moving and selling goods in foreign markets (helps international trade) MNCs are skilled in making investments in foreign real assets (helps FDI) MNCs are skilled in business contracting (helps trade as well as FDI)

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C3. Special Risks Faced by MNCs

Currency Risk: affects transactions, assets and operations Economic Risk: macro-economic variables such as inflation are highly variable Political and Regulatory Risk: MNCs deal with foreign governments and regulatory bodies Variation in Business Processes: business is often conducted using different methods globally

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C4. MNCs and the Agency Problem

MNCs wish to maximize shareholder wealth Difficulties arise because:

MNCs are large with dispersed operations (monitoring and control are difficult) MNCs produce and sell a large number of products (complexity provides opportunity for managers to deviate from overall goals) MNCs are typically highly de-centralzied (unit-level managers have more power, can be abused)

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D1. US Governance Model

Independent board of directors Incentive contracts for managers Accounting procedures are geared toward reasonably transparent reports for the benefit of external investors Vigilant markets Vigilant regulators

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D2. Governance in Asia

Family Control Boards dominated by insiders Mergers are infrequently used to discipline poor management Accounting reports not always transparent Minority shareholder rights not always respected

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E. International Financial Management Issues

Understanding the environment: global markets, especially currency related markets Managing currency risk: measure and manage risk, understand multiple methods of risk control International Project Analysis: understand various nuances in capital budgeting Global Financing: how to source capital globally and decrease the cost of capital Global Operations: methods of conducting global business and penetrating new markets

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