Multinational Corporation (MNC)
A multinational corporation (MNC) has facilities and other
assets in at least one country other than its home country. A
multinational company generally has offices and/or factories in
different countries and a centralized head office where they
coordinate global management. These companies, also known as
international, stateless, or transnational corporate organizations
tend to have budgets that exceed those of many small countries.
How a Multinational Corporation (MNC) Works
A multinational corporation, or multinational enterprise, is an
international corporation that derives at least a quarter of its
revenues outside its home country. Many multinational enterprises
are based in developed nations. Multinational advocates say they
create high-paying jobs and technologically advanced goods in
countries that otherwise would not have access to such
opportunities or goods. However, critics of these enterprises
believe these corporations have undue political influence over
governments, exploit developing nations, and create job losses in
their own home countries.
The history of the multinational is linked with the history of
colonialism. Many of the first multinationals were commissioned at
the behest of European monarchs in order to conduct expeditions.
Many of the colonies not held by Spain or Portugal were under the
administration of some of the world's earliest multinationals. One
of the first arose in 1660: The East India Company, founded by the
British. It was headquartered in London, and took part in
international trade and exploration, with trading posts in India.
Other examples include the Swedish Africa Company, founded in 1649,
and the Hudson's Bay Company, which was incorporated in the 17th
century.
Types of Multinationals
There are four categories of multinationals that exist. They
include:
- A decentralized corporation with a strong presence in its home
country.
- A global, centralized corporation that acquires cost advantage
where cheap resources are available.
- A global company that builds on the parent corporation’s
R&D.
- A transnational enterprise that uses all three categories.
There are subtle differences between the different kinds of
multinational corporations. For instance, a transnational—which is
one type of multinational—may have its home in at least two nations
and spread out its operations in many countries for a high level of
local response. Nestlé S.A. is an example of a transnational
corporation that executes business and operational decisions in and
outside of its headquarters.
Meanwhile, a multinational enterprise controls and manages
plants in at least two countries. This type of multinational will
take part in foreign investment, as the company invests directly in
host country plants in order to stake an ownership claim, thereby
avoiding transaction costs. Apple Inc. is a great example of a
multinational enterprise, as it tries to maximize cost advantages
through foreign investments in international plants.
According to the Fortune Global 500 List, the top five
multinational corporations in the world as of 2019 based on
consolidated revenue were Walmart ($514 billion), Sinopec Group
($415 billion), Royal Dutch Shell ($397 billion), China National
Petroleum ($393.01 billion), State Grid ($387 billion).
Advantages and Disadvantages of
Multinationals
There are a number of advantages to establishing international
operations. Having a presence in a foreign country such as India
allows a corporation to meet Indian demand for its product without
the transaction costs associated with long-distance shipping.
Corporations tend to establish operations in markets where their
capital is most efficient or wages are lowest. By producing the
same quality of goods at lower costs, multinationals reduce prices
and increase the purchasing power of consumers worldwide.
Establishing operations in many different countries, a
multinational is able to take advantage of tax variations by
putting in its business officially in a nation where the tax rate
is low—even if its operations are conducted elsewhere. The other
benefits include spurring job growth in the local economies,
potential increases in the company's tax revenues, and increased
variety of goods.
A trade-off of globalization—the price of lower prices, as it
were—is that domestic jobs are susceptible to moving overseas. This
suggests that it’s important for an economy to have a mobile or
flexible labor force so that fluctuations in economic temperament
aren't the cause of long-term unemployment. In this respect,
education and the cultivation of new skills that correspond to
emerging technologies are integral to maintaining a flexible,
adaptable workforce.
Those opposed to multinationals say they are ways for
corporations to develop a monopoly (for certain products), driving
up prices for consumers, stifling competition, and inhibiting
innovation. They are also said to have a detrimental effect on the
environment because their operations may encourage land development
and the depletion of local (natural) resources.
The introduction of multinationals into a host country's economy
may also lead to the downfall of smaller, local businesses.
Activists have also claimed that multinationals breach ethical
standards, accusing them of evading ethical laws and leveraging
their business agenda with capital.
Financing
Financing the working capital requirements of a
multinational companies foreign affiliates poses a complex
decision problem. This complexity stems from the large number of
financing options available to the subsidiary of an MNC.
Subsidiaries have access to funds from sister affiliates and the
parent, as well as external sources. This article focuses on
developing policies for borrowing from either within or without the
companies when the risk of exchange rate changes is present and
different tax rates and regulations are in effect.
There are four aspects of short-term overseas financing
strategy namely;
- Identifying the key factors,
- Formulating and evaluating objectives,
- Describing available short-term borrowing options
and
- Developing a methodology for calculating and comparing the
effective after-tax dollar costs of these alternatives.
1. Identifying Key Factors
There are six key factors in short- term financing the MNCs they
are deviations of interest rates, exchange risk, degree of risk
aversion, borrowing strategy and currency risk, tax asymmetries and
political risk.
- Deviations in the rate of interest are the
first risk factor. If forward contracts are unavailable, the
crucial issue is whether differences in nominal interest rates
among currencies are matched by anticipated exchange rate changes.
The key issue here is whether there are deviations from the
international rate of interest. If deviations do exist, then
expected dollar borrowing costs will vary by currency, leading to a
decision problem. Trade–offs must then be made between the expected
borrowing costs and the exchange risks associated with each
financing option.
- The element of exchange risk is the second key
factor. Many firms borrow locally to provide an offsetting
liability for their exposed local currency assets. On the other
hand, borrowing a foreign currency in which the firm has no
exposure will increase its exchange risk. What matters is the
co-variance between the operating and financing cash flows. That is
the risk associated with borrowing in a specific currency is
related to the firm’s degree of exposure in that currency.
- The Third essential element is the firm’s degree of
risk aversion. The more risk averse the firm (or its
management) is, the higher the price it should be wiling to pay
reduces its currency exposure. Risk aversion affects the company’s
risk-cost, trade-off and consequently, in the absence of forward
contacts, influences the selection of currencies it will use to
finance its foreign operations.
- Borrowing Strategy and currency risk of the
MNCs are the fourth risk factor. If forward contracts are
available, however, currency risk should not be a factor in the
firm’s borrowing strategy. Instead, relative borrowing costs,
calculated on a conversed basis, become the sole determinant of
which currencies to borrow in. The key issue here is whether the
nominal interest differential equals the forward differential–that
is, whether interest rate parity holds, then in the absence of tax
considerations, the currency denomination of the firm’s debt is
irrelevant.
- Tax asymmetries are the next risk factor. That
is even if interest rate parity does hold before tax, the currency
denomination of corporate borrowing does matter where tax
asymmetries are present. These tax asymmetries are based on the
differential treatment of foreign exchange gains and losses on
either forward contracts or loan repayments.
- The last risk is the political risk. Even if
local financing is not the minimum cost option, multinationals will
often still try to maximize their local borrowing if they believe
that expropriation or exchange controls are serious possibilities.
If either event occurs, an MNC has fewer assets at risk if it has
used local, rather than external, financing.
2. Formulating and Evaluating Objectives
The following are the objectives of the short-term financing the
MNCs.
- Minimize expected cost. By ignoring this
objective reduces information requirements, allows borrowing
options to be evaluated on an individual basis without considering
the correlation between loan cash flows and operating cash flows,
and lends itself readily to break-even analysis.
- Minimize risk without regard to cost. A firm
that followed this advice to its logical conclusion would dispose
of all its assets and invest the proceeds in government securities.
In other words, this objective is impractical and contrary to
shareholder interests.
- Trade of expected cost and systematic risk.
The advantage of this objective is that, like the first objective,
it allows a company to evaluate different loans without considering
the relationship between loan cash flows and operating cash flows
form operations. More over, it is consistent with shareholder
preferences as described by the Capital Asset Pricing Model (CAPM).
In Practical terms, however, there is probably little difference
between expected borrowing cost adjusted for systematic risk and
expected borrowing costs without that adjustment. This lack of
difference is because the correlation between currency fluctuations
and a well diversified portfolio of risky assets is likely to be
quite small.
- Trade of expected cost and total risk.
Basically, it relies on the existing of potentially substantial
costs of financial distress. On a more practical level management
generally prefers greater stability of cash flows (regardless of
investor preferences). Management will typical self-insure against
most losses, but might decide to use the financial markets to hedge
against the risk of large losses.
3. Short-term Financing Options
The following are the options available to finance the MNCs.
- The inter-company,
- The local currency loan, and
- Euro notes and Euro-commercial paper.
Inter-company Financing
This is the most common short term financing system among the
MNCs. Here under this system, either the parent company or sister
affiliate provide an inter-company loan. At times, however, these
loans may be limited in amount or duration by official exchange,
controls, etc. In addition, interest rates on inter-company loans
are frequently required to fall within set limits. Normally, the
lender’s government will want the interest rate on an intercompany
loan to be set as high as possible for both tax an
balance-of-payments purposes, while the borrower’s government will
demand a low interest rate for similar reasons.
Local Currency Financing
This is another common system of financing the MNCs. Like the
domestic firms, subsidiaries of multinational Companies generally
attempt to finance their working capital requirements locally, for
both convenience and exposure management purposes. Since all
industrial nations have well-developed commercial banking systems,
firms desiring local financing generally turn there first. The
major forms of bank financing include overdrafts, discounting, line
of credit, revolving credit and term loans.
- Term Loans: Loans from commercial banks are
the dominant form of short-term interest-bearing financing used
around the world. These loans are described as self-liquidating
because they are usually used to finance temporary increases in
accounts receivable and inventory. These increases in working
capital are soon converted into cash, which is used to repay the
loan. Short-term bank credits are typically unsecured. The borrower
signs a note evidencing its obligation to repay the loan when it is
due, along with accrued interest. Most notes are payable 90 days;
the loan must, therefore, be repaid or renewed every 90 days. The
need to periodically roll over bank loans gives substantial control
over the use of its funds, credits are not being used for permanent
financing, a bank will usually insert a cleanup clause requiring
the company to be completely out of debt to the bank for a period
of at least 30 days during the year.The interest rate on bank loans
is based on personal negotiation between the banker and the
borrower. The loan rate charged to a specific customer reflects
that customer’s creditworthiness, previous relationship with the
bank, the maturity of the loan, and other factors. Ultimately, of
course, bank interest rates are based on the same factors as the
interest rates on the financial securities issued by a borrower:
the risk-free return, which reflects the time value of money, plus
a risk premium based on the borrower’s credit risk. However, there
are certain bank loan pricing conventions that you should be
familiar with. Interest on a loan can be paid at maturity or in
advance. Each payment method gives a different effective interest
rate, even if the quoted is the same.
- Overdrafts: An overdrafts is simply a line of
credit against which drafts (checks) can be drawn (written) upto a
specified maximum amount. These overdraft lines are often extended
and expanded year after year, thus providing in effect, a form of
medium-term financing. The borrower pays interests on the debit
balance only.
- Line of Credit: Arranging separate loans for
frequent borrowers is a relatively expensive means of doing
business. One way to reduce these transaction costs is to use a
line of credit. This formal agreement permits the company to borrow
up to a stated maximum amount from the bank. The firm can draw down
its line of credit when it requires funds and pay back the loan
balance when it has excess cash. Although the bank is not legally
obligated to honour the line-of-credit agreement, it almost always
does unless it or the firm encounters financial difficulties. A
line of credit is usually good for one year, with renewals
renegotiated every year.
- Revolving Credit Agreement: A revolving credit
agreement is similar to a line of credit except that now the bank
(or syndicated of banks) is legally committed to extend credit up
to the stated maximum. The firm pays interest on its outstanding
borrowings plus a commitment fee, ranging between 0.125% and 0.5%
per annum, on the unused portion of the credit line. Revolving
credit agreements are usually renegotiated every two or three
years. The danger that short-term credits are being used to fund
long-term requirements is particularly acute with a revolving
credits line that is continuously renewed; inserting an out-of-debt
period under a cleanup clause validates the temporary need for
funds.
- Discounting: Discounting usually results from
the following set of transactions. A manufacturer seller goods to a
retailers on credit draws a bill on the buyer, payable in, say, 30
days. The buyer endorses (accepts) the bill or gets his or her bank
to accept it, at which point it becomes a banker’s acceptance. The
manufacturer then takes the bill to his or her bank, and the bank
accepts it for a fee if the buyer’s bank has not already accepted
it. The bill is then sold at a discount to the manufacturer’s banks
or to a money maker dealer. The rate of interest varies with the
term of the bill and the general level of local money market
interest rates.
SOURCES :
https://www.investopedia.com/terms/m/multinationalcorporation.asp
https://www.mbaknol.com/international-finance/short-term-financing-of-multinational-corporations/
https://link.springer.com/chapter/10.1057%2F9781137356932_3