Managing Foreign Investment

ManagingForeign Investment W. Christian Buss School of Business University at Albany

Learning Objectives #12 • Describe and evaluate the function of international finance markets • Explain what the major sources of financial risk are and how they are managed • Show how operating policies can be used to manage risk • List methods for reducing loss after expropriation

International Capital Markets • Global financial markets can be classified as internal (national) and external. Internal markets include domestic and foreign markets. External markets are called international, offshore, and Euro-markets. • Domestic markets are where home country entities raise capital. • Foreign markets are where foreign issuers sell securities denominated in the currency of the home country.

Int’l Capt’l Markets (cont.) • A MNE uses both domestic and foreign markets to finance its activities. • The foreign bond market is where foreign corporations and governments issue bonds denominated in the home country’s currency. In the US, dollar denominated bonds sold by foreign entities are called Yankee bonds (yen denominated bonds in Japan - Samurai bonds, in UK - Bulldog bonds, in Netherlands - Rembrandt bonds, in Spain - Matador bonds).

Int’l Capt’l Markets (cont.) • The foreign bank market is where domestic banks make loans to foreigners for use abroad. • Loans between banks are traded in London at the London Inter-Bank Offered Rate (LIBOR). Foreign, hard-currency debt transactions are often quoted at LIBOR + X basis points. Rate depends on credit-worthiness of the borrower.

Int’l Capt’l Markets (cont.) • The foreign equity market is where foreign corporations sell stock (in the US, foreign stock issues sold for dollars are called Yankee stock issues). • A foreign corporation may sell equity (stock) in a foreign country to diversify funding risk, expand the market for an issue too large to be sold domestically, increase potential demand for its shares, or project an international image by spreading its name in local (host country) markets. • American Depository Receipts (ADR’s) are used by foreign corporations to access the US Stock Market. ADR’s represent shares of stock deposited in the US. They can be traded like stock, but do not allow access to equity capital.

Eurocurrency Market • A Eurocurrency is a currency deposited in a bank outside its country of origin. For example, US dollars deposited in London are termed Eurodollars. • The Eurocurrency market consists of those banks that accept deposits and make loans in foreign currencies. Most deposits are non-negotiable time deposits. • The interest rate at which Eurocurrency loans are made is called the London interbank offer rate (LIBOR).

Eurocurrency (cont.) • Most Eurocurrency loans are made on a floating rate basis (indexed to LIBOR) with a six month indexing period. The maturity of loans can be up to 10 years. Many loans are made by a syndicate of banks. Loans can be term loans or loans under a line of credit or revolving credit agreement. • Note issuance facilities (NIFs) allow borrowers to issue their own short-term Euronotes. Euronotes typically mature in one year or less. An issuer and a syndicate of banks agree on a maximum amount to be financed, the length of the agreement, and a price (spread over LIBOR). When an issuer decides to issue Euronotes, the banks in the syndicate purchase the notes at the predetermined spread over LIBOR; the Euronotes are then sold to investors.

Financial Management • Global Cash Management • Local and MNE cash requirements • Cash/Profit withdrawal from subsidiaries • Cash reallocation and use • Cash flows represent FX risk exposure which can be reduced by netting. Total receivables less total payables are balanced across subsidiaries as much as possible.

Financial Risk Management • Inflation • FX Exposure • Translation Exposure • Transaction Exposure • Economic Exposure Exposure Management Strategy: 1) Define and measure exposure, 2) Organize and implement a reporting system, 3) Assign responsibility for hedging the exposure, and 4) Formulate strategies for hedging exposure.

Managing Risk After a MNC has assessed the degree of risk, it can follow four separate (but not necessarily mutually exclusive) policies. • Avoidance. All foreign investments involve some degree of political risk. A MNC will not invest in countries where the expected return does not compensate for the perceived risk. • Insurance. Most developed countries sell political risk insurance to cover the foreign assets of domestic corporations. In the US, this type of insurance is provided by the Overseas Private Investment Corporation (OPIC). OPIC provides US firms with insurance against loss due to expropriation, currency inconvertibility, and political violence.

Managing Risk (cont.) • Negotiating with HC government. A firm may be able to reach an agreement with the host country defining the rights and responsibilities of both parties (concession agreement). Unfortunately, these agreements can be repudiated by new governments. • Structure the investment. A firm can attempt to minimize its exposure to political risk by increasing the host country’s cost of interfering with the company’s operations. The firm is trying to link the value of the foreign project to the MNE's continued control. Examples of actions include vertical integration, control of proprietary technology, multiple sourcing, and financing the project from the host and other governments and international financial institutions.

Managing Risk:Operating Policies Once the MNC has invested in a project, there are still policies that it can pursue to protect its investment. • Planned divestment. A MNC can phase-out their ownership over a fixed period of time by selling all or a majority interest to local investors. • Short-term profit maximization. If a MNC believes there is risk of expropriation, it may respond by withdrawing the maximum amount of cash from the local facility (e.g., deferring maintenance, eliminating training). Such an action may, however, accelerate expropriation. Short-term profit maximization may also be unwise if the unfriendly government is replaced by a more friendly one or the MNC wishes to sell in the local market from affiliates in other countries.

Managing Risk:Operating Policies • Changing the benefit/cost ratio. A MNC can increase the benefits of their continued ownership by establishing R&D facilities locally, developing export markets, training local personnel, and/or expanding local production facilities. The costs of expropriation can be increased by controlling export markets, transportation, technology, brand names, and components. • Developing local stakeholders. Stakeholders include consumers, suppliers, employees, financial institutions, and other equity investors. Once the MNC has invested in a project, there are still policies that it can pursue to protect its investment.

Post-Expropriation Actions • Rational negotiation. The aim is to maintain contact with the host country in an effort to persuade it to change its decision. • Applying power. The MNC may cut off vital components, export markets, technology, and management skills. However, it is likely that the government has anticipated these actions and has decided that they were not sufficiently harmful.

Post-Expropriation Actions • Legal remedies. During the first two phases, the MNC will begin to seek legal redress. Legal relief must first be sought in the courts of the host country. The MNC can also petition home country courts for relief. However, the doctrine of sovereign immunity says that a sovereign state may not be tried in the courts of another state without its consent and the act of state doctrine states that a nation is sovereign within its own borders, and its domestic actions may not be questioned in the courts of another country, even if those actions violate international law.

Post-Expropriation Actions • Management surrender. As a final act the MNC accepts the inevitable and attempts to salvage whatever is possible. A MNC can earn income without owning assets by handling exports on a commission basis, furnishing technical and management skills, and providing raw materials.

Nothing Fails Like Success When Environments Change ... Sources of success may become seeds of failure Xerox: Proficient at selling high end copiers to an expanding market with no competition Japanese competitors underpriced Xerox Entered the low end of the market and moved up THEREFORE Adapt to Global Environment

Common Characteristics of High-Performing Asian Countries • More rapid output and productivity growth in agriculture. • Higher rates of growth of manufactured exports. • Earlier and steeper declines in fertility.

High-Performing Asian Countries (cont.) • Higher growth rates of physical capital, supported by higher rates of domestic savings. • Higher initial levels and growth rates of human capital. • Generally higher rates of productivity growth. Would you want to build an operation in these countries?

Five Modes of Entry Indirect Exporting Direct exporting Licensing Joint ventures Direct investment Amount of commitment, risk, control, and profit potential

McDonald’s • Why replace Ex-pats with HCN’s? • Why Select Russia? • What was the biggest problem in establishing a Russian presence?

Managing Foreign Investment