Multinational Companies and Domestic Companies - Essay Example

?Discuss the Agency Problem Relating to Multinational Companies, and in Particular Multinational Banks, and How, they Differ from Domestic Companies and Domestic Banks Table of Contents Introduction 3 Two Most Common Agency Problems in Banks 4 Agency Problems and Risk Taking at Multinational Banks 4 Examining Prudential Regulation of Multinational Banks 5 Examining Regulatory Factors for Mitigating Agency Problems 6 Creation of Economic Value by Multinational Banks 8 Corporate Governance and Agency Problems 8 Corporate Governance and Risk Taking Behavior of banks 9 Comparison of Agency Problems in Multinational Banks and Domestic banks 10 Conclusion 13 References 14 Bibliography 18 Introduction This paper is an ample discussion on the agency problem faced by both the multi-national as well as domestic companies, especially banks. The discussion will mainly be focused on the agency problems faced by multinational companies and their level of difference from those of the domestic companies. The situation of agency problem is such in many of the organizations that the agents or the management of the organization makes use of their authority for deriving personal benefits rather than benefits of the principals or the shareholders. In other words, agency problem arises due to the conflicting interests among the management, creditors and shareholders’ regarding the goals of the organization as well as that of the concerned parties (Investopedia, 2011). The agency problem in multinational companies can be appropriately discussed by focusing on the ways as to how the supervision and regulation affects the risk-taking measures of the banks in the host-country (Ongena & Et. Al., 2011). This research paper is aimed to present the discussion on agency problem in multinational companies, particularly banks, through review of various aspects related to the evolution of the problems. The research also aims to present a comparative study of the agency problems faced by the multinational organizations and domestic organizations. Two Most Common Agency Problems in Banks In the non-financial corporations, an incentive is provided to the shareholders through limited liability that allows them to seize bondholders’ wealth by increasing the level of risk. The government is indulged in protecting the bond holders from the outcome of risk taking activities of the banks. Thus, the shareholders’ incentive to supervise and restrain risk taking is low. In the banking literature, such situation of absence of discipline is known as the “moral hazard problem associated with deposit insurance”. A second very common situation of agency problem arises due to the limits on the wealth of managers that forces a separation of control and ownership. This forces the managers to consider their own objectives to be more important than that of the shareholders (Demsetz, 1997). Agency Problems and Risk Taking at Multinational Banks The root cause of agency problems in multinational companies, particularly banks is related to the structuring of regulations for multinational banking units. The host country is more interested in structuring the regulations in such a way that would provide disadvantage to the foreign firms to compete with the domestic firms. But this notion would result in inconsistency with the objective of a single market (Baum, 2002). The consequence of leaving the supervision and regulation in the home country, as evident from the case of the European Union, is that the member countries adopted different structures of regulation and supervision for the financial institutions. Thus, if the multinational banks are faced with similar regulatory issues, they would either split according to functions or would consolidate regulation into one agency. In that case, in certain situations the Central Bank will be involved, whereas in other cases, it would not. Hence, it is evident that considering these regulatory issues, the multinational banks would select policy trade-offs on the basis of their degrees of responsibilities and mandates of individual statutory issues. The consequences would be nothing but either external resolutions or internal resolutions which would form the basis of agency problems (Eisenbeis, 2004). Examining Prudential Regulation of Multinational Banks This section of the paper is aimed at discussing the regulatory intervention’s dependence on the form of representation for the host country’s units. The representation form of the host country’s units i.e. the foreign units are the insurance arrangements and liability structures for depositors of non-local individuals. The incentives for national regulators for intervening in a unit will have an impact from the available assets for compensating depositors. Particularly, liability shared among the units of multinational banks is effective in reducing the intervention costs in each unit when compared to the scenario where each of the units is separate legally (Madura, 2008). This is because of the fact that the regulator would be then able to reduce the intervention cost in a particular unit with another unit’s assets. This aspect of the regulation in multinational banks also relieves the regulator from taking up huge responsibilities for insuring depositors in both the countries. With representation of subsidiaries, the foreign regulator has more incentives in monitoring than that of the home regulator (Calzolari & Loranth, 2005). Examining Regulatory Factors for Mitigating Agency Problems From the discussion in the above sections, it is evident that regulation is a combination of certain legal norms that jointly determines the preference structures of bank’s managers and shareholders. On the other hand, supervision is the process through which policymakers influences the daily operations of banks. The regulator of the domestic bank may sustain equilibrium with a high level of cohesion among the managers of the branches in multinational banks under its own jurisdiction if there is a sudden change in the process of creating credit in the home country due to either a real or financial disorder (Barry & Et. Al., 2010). In this scenario, if several borrowers of the host countries are dependent on loan from the bank that is regulated by foreign control, then the change in credit creation process will have a macro-effect. This has a subsequent implication for financial stability of the real sector. The domestic regulator is not able to change the operation of the foreign controlled incumbent bank. But an appropriate regulatory bearing can contribute by encouraging other banks’ entry for providing the required adverse funds. In this esteem, one important criterion of the supervisory and regulatory policies would be to strive for reducing the monitoring costs of the managers. This will substantially reduce the agency problems, specifically in the foreign bank units which manages heavy loans. Hence, as a result the units will not work as transmitters of disorders from the home country’s bank to the credit market of the domestic countries (Derviz, 2005). Creation of Economic Value by Multinational Banks Post financial crisis, doubts have been raised on the abilities of the multinational banks regarding creation of economic value. Doubts are prominent in case of large banks, regarding that they are too big and thus, risky. Despite the vast analysis of internalization process of banks over the past many years, it has not yet been proved that expansion from the cross-border perspective is a profitable process from a firm’s point of view. The most important area of research is to sort out whether the cross border expansion of the multinational banks adds value to the firms from the shareholders’ point of view. It is evident from previous literatures that diversification can enlarge value of firms and thus increase their market power. The multinational firms, at the same time, can enable more efficient use of the human and physical resources but it is also evident that the benefits can even reduce due to the agency problems. But the present research depicts that the benefits derived from the scope of economic and geographic scale are more than the agency costs (Gulamhussen & Et. Al., 2011). Corporate Governance and Agency Problems On examining the impact of franchise value, structure of ownership, ethics of corporate governance and bank regulations on the risk taking nature of the banks, quite a few implications can be derived. The large owners who have rights on substantial flow of cash provoke the banks for increasing risk. This finding is consistent with the fact that equity holders bear the incentive for increasing risk after the deposits and debts are collected from the investors. However, there is little impact of the franchise value of banks or laws of investor protection on the risk taking behavior of the banks (Alexander, 2004). In terms of regulatory policies, banks’ official supervisory and capital requirements do not contribute in reducing risks. Rather, it is evident that a regulation whose aim is to promote diversification in loan undertakings, contributes in reducing risk initiative of the banks. On the other hand, the regulations that restricts the banks from incorporating diversification in generating income flowing through provision of non-lending services, results in increased risk taking by the banks (Laeven & Levine, 2006). Corporate Governance and Risk Taking Behavior of banks The structures of corporate governance have crucial importance for choice of managerial risk undertaking for deciding on investing on corporate projects. Particularly, the structures of managerial compensation within an organization can endanger the risk appetite of the managers. The design of the incentive compensation actually makes trade-off between agency problems and considerations on risk sharing. Evaluation of risk taking nature and compensation factor of the managers suggest that the bank managers should be provided a bonus along with the fixed salary and a portion of the bank’s equity (Chibundu, 2008). Comparison of Agency Problems in Multinational Banks and Domestic banks The domestic companies, specifically the domestic banks’ agency problems will be taken up in this section with respect to the Chinese domestic markets and will be compared with the multinational companies’ or banks’ agency problems. Reforms in enterprises that are state-owned in China suggest that several effective rights of control have been provided to the managers along with maintaining the rights of control for the government and the party. The consequences of these facts either result in increased agency cost due to the lack in accountability on the part of the managers or result in increased political costs because of higher political interference of the government. The reforms should be aimed at reduction of both agency as well as political costs. This can be done through various measures like deteriorating socialism, deteriorating politics and through useful corporate governance. It is evident that Chine needs a transformation of ownership, a system of state’s asset management and corporatization for achieving the results. Thus, it can be observed on comparing the agency problems in multinational banks and domestic banks, particularly in China that the problems are sufficiently similar considering the regulatory actions undertaken for governing the banks’ functionalities (Qian, 1996). In spite of the prevalence of modern mechanisms of corporate governance and the dominance power of the state-owned Chinese major banks, the enforcement capability and the mode of operating in decentralized way have presented serious challenges as regards to the agency problems in the country. Strong maintenance of corporate governance issues is most required in China as the multi layered agency problems have initiated several undesired behaviors from the managers. These behaviors are detrimental for both the minority as well as majority shareholders and are initiated from the insiders’ powers. The corporate delinquencies and scandals are the evidences of such issues in China. It seems that in case of multinational banks, the issues of insider’s power were not as prominent as that in case of domestic banks in China (Tam, 2008). It can be enumerated through an example that inefficient corporate governance and ineffective monitoring control have been the reasons of failure in Chinese banking system. Due to these ineffective mechanisms, the managers of the banks are not able to work up to the states’ best interests. As a result of this, there arose agency problems and various controlling problems related to political issues. The table below shows the records of assets and liabilities of Chinese banking system as at 31st December, 2003 which had been a result of the agency and political problems (Yan, 2008). Source: Yan, 2008. The domestic banks in China consider the reduction in non-tax cost as an important strategy for sustainability. This is because this strategy provides the Chinese domestic firms the initiative of engaging in shifting of income across the Chinese jurisdiction. However, many strategies aimed at minimizing taxes might result in lowering of income reported on books and this entire fact can lead to increased cost of non-tax paradigm initiated by pressure from the capital market or agency problems. Thus, the domestic banks look after mitigating the agency costs even before taking up strategies related to income shifting of the individuals. This factor of the agency problems cannot be considered as big as that of multinational banks since for taking up any strategy in the parent country, the multinational banks would have to consider the regulatory facts in its entire set of operating units located worldwide (Shevlin & Et. Al., 2009). On comparing the uses of long term debt from multinational and domestic firms in China, it can be evaluated that multinational firms make less use of long tern debts than that of domestic firms. This is because the agency problems related to the costs of long term debts are significantly higher for multinational firms than that of the domestic firms. The increasing foreign involvement of the multinational firms worsen the agency problems related to debt and thus, leads to lower utilization of long term debt (Doukas & Pantzalis, 2003). Conclusion The research paper has provided a comprehensive analytical report on the agency problems faced by the multinational banks with special notification to the comparison between these firms and that of the Chinese domestic firms. It is evident from the research conducted in this paper that multinational firms are more affected by the agency problems and this is the reason as to why lower long term debt is widely used by the multinational firms than that of the domestic firms. The reasons behind the higher exposure of agency problems by the multinational firms are regulatory forces and corporate governance and hence more degree of foreign involvement. The comparative analysis however suggested that the initiation of strategies by the multinational and domestic firms should be different in nature while considering the worldwide perspectives. But it is also evident that handling insider issues definitely require higher efficiency with respect to corporate governance in both the cases. References Alexander, K., 2004. Corporate Governance and Banking Regulations. Working Paper 17. Barry, T. A. & Et. Al., 2010. Ownership Structure and Risk in Publicly Held and Privately Owned Banks. Journal of Banking and Finance 35 (2011)1327-1340. Baum, J. A. C. 2002. The Blackwell Companion to Organizations. Wiley-Blackwell. Calzolari, G. & Loranth, G., 2005. Regulation of Multinational Banks: A Theoretical Enquiry. European Central Banks; Working Paper Series No. 431. 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Do Multinational Banks Create or Destroy Economic Value?. Economics and Statistics Discussion Paper No. 057/11. [Online] Available at: http://road.unimol.it/bitstream/2192/125/4/ESDP11057.pdf [Accessed April 04, 2011]. Investopedia, 2011. Agency Problem. Terms. [Online] Available at: http://www.investopedia.com/terms/a/agencyproblem.asp [Accessed April 04, 2011]. Laeven, L. & Levine, R., 2006. Corporate Governance, Regulation, and bank Risk Taking. Corporate Finance. [Online] Available at: http://fic.wharton.upenn.edu/fic/corporate%20finance%202006/Levine.pdf [Accessed April 04, 2011]. Madura, J., 2008. International Financial Management. Cengage Learning. Ongena, S. & Et. Al., 2011. Bank Risk-Taking Abroad: Does Home-Country Regulation and Supervision Matter?. Papers. [Online] Available at: http://www.alexanderpopov.org/Papers/Bank_regulation_supervision_and_cross_border_risk_taking.pdf [Accessed April 04, 2011]. Qian, Y., 1996. Enterprise Reform in China: Agency Problems and Political Control. Stanford University. [Online] Available at: http://elsa.berkeley.edu/~yqian/94-2.pdf [Accessed April 04, 2011]. Shevlin, T. & Et. Al., 2009. Domestic Income Shifting by Chinese Listed Firms. Tax Readings Group. [Online] Available at: http://www.mccombs.utexas.edu/tax-readings-group/papers/Domestic_Income_Shifting_by_Chinese_Listed_Firms.pdf [Accessed April 04, 2011]. Tam, O. K., 2008. Emerging Best Governance Practices in Commercial Financial Institutions: Corporate Governance in Chinese Banks. Australian Leadership Awards-Fellowship. [Online] Available at: http://www.apec.org.au/docs/08_ALA_RT/S7_Tam.pdf [Accessed April 04, 2011]. Yan, W., 2008. China’s Banking Sector Reform from Corporate Governance Perspectives. Regional Studies. [Online] Available at: http://www.iuk.ac.jp/chiken/pdf/regional_studies35_2-3.pdf [Accessed April 07, 2011]. Bibliography Eisenhardt, K. M., 1989. Agency Theory: An Assessment and review. 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