Question

What factors would cause a MNC to increase leverage as it expands overseas?

Answer 1

Multinational corporations leverage their financial position and access to global markets to raise capital in a cost-effective and efficient manner. This gives these companies an advantage over small domestic operators that do not have the same level of credit or cash, but there are risks associated with international finance. The capital structure multinationals use directly impacts profitability, growth and sustainability.

The factors that would cause a MNC to increase leverage as it expands overseas are as follows:

Invested Capital

A multinational’s capital structure comprises the sources of money used to finance operations, expand production or purchase assets. Companies acquire capital through the sale of securities in financial markets such as the New York Stock Exchange or the London Stock Exchange. Debt and equity are the two forms of capital that multinationals have to choose from, and each form has its advantages and disadvantages. The cost of raising capital is an important component of financing decisions.

Debt Financing

Acquiring debt capital is a process that is contingent on the availability of funds in the global credit markets, interest rates and a corporation’s existing debt obligations. If credit markets are experiencing a contraction, it may be difficult for the corporation to sell corporate bonds at favorable rates. In particular, it may be challenging to get high advance rates for asset-backed securities. If a firm becomes over-leveraged, it may be unable to pay its debt obligations leading to insolvency. However, debt costs less to acquire than other forms of financing.

Equity Financing

Preferred stock, common stock and components of retained earnings are considered equity capital. It is important for a multinational to carefully analyze its equity cash flows and mitigate the risk associated with currency fluctuations. Otherwise, it may lose equity due to changes in exchange rates. Also, the issuance of new shares may cause stock prices to fall because investors no longer feel company shares are worth their pre-issuance price. Offering stock in global financial markets costs multinationals more than acquiring debt, but it may be the right financing option if a corporation is already highly leveraged.

Tax Considerations

Multinationals have the option to shift income to jurisdictions where the tax treatment is the most advantageous. As a result, debt and equity financing decisions are different relevant to solely domestic companies. If income is reported in the United States, it may be beneficial to obtain debt financing, because the interest is tax-deductible. When making capital structure decisions, multinationals must evaluate their tax planning strategies to minimize their tax liabilities.