Question

1. What are some motives and alternative instruments to source equity globally?

2. Is there optimal capital structure for multinationals?

Answer 1

1) In sourcing equities globally, there are two things involved- first is the time involved in rasing money and second is the amount of preliminary costs incurred in order to raise equities globally. Therefore, to save the time or in other words to raise funds quickly without incurring much preliminary cost is the main motive as to why firms try to find out alternative instruments to source equity globally. Some of the alternative instruments are:

a) Sale of shares to a targeted public market

b) Sale of shares through private placement in form of right issues

c) Sale of shares to private equity investors

d) Sale of shares to large institutional investors such as insurance firms, banks, etc.

e) Sale of shares to foreign firm to form strategic alliance.

2) There is no such defined capital structure defined for MNCs but there are certain parameters on which MNCs can decide on the proportion of debt and equity in a capital structure:

a) Cost of Financing in debt in much lower as compared to raising funds through equity. In raising equity, there are preliminary costs involved which is a very huge number and is a major cash outflow for the company. Moreover, the interest paid on debt is much lower on debt as compared to equity. But an overleveraged firm can become bankrupt if it is not able to pay the debt back on time. Also, tax consideration makes the usage of debt financing much attractive.

b) In raising equity, the firm is able to mitigate the risk to other shareholders. But with this MNC can lose its controlling stake in the company and can also become a victim of hostile takeover.