International Financial Strategies - Essay Example

?International Financial Strategies Introduction The term corporate governance reflects a set of rules and processes based on which business operation is normally controlled and regulated. Corporate governance can be defined as “the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled” (Solms & Solms, 2008, p.2). An attractive theme of corporate governance is its mechanisms that try to avoid the principal-agent problem. In the view of economists, the 2007 global economic crisis could be attributed to the corporate governance failure. In recent years, especially after the collapse of American corporate giants like Enron, WorldCom, and Parmalat, organisations have been vehemently working to improve their corporate governance. Many of the economists strongly hold the view that a global approach is necessary to regulate corporate governance in order to prevent such corporate failures in future. This paper will critically analyse whether or not a global approach to regulate corporate governance would be effective. It will also discuss the effects and benefits that this strategy may cause on multi-national companies. Corporate governance The concept of corporate governance has undergone tremendous changes since its origin. Managements always pay attention to update their corporate governance strategy in accordance with the needs of time. The corporate governance policy also maintains the relationship between the stakeholders and the objectives of the organisation (OECD, 2004). Top level mangers always focus on the impact of their corporate governance strategy on economic efficiency in addition to a strong emphasis on shareholder values. Since a series of corporate failures in 2001 were attributed to accounting fraud, today organisations focus on internal check policies while formulating their corporate governance strategy. Likewise, corporate scandals of various forms during the last decade attainted public and political interest, which greatly contributed to strict regulation of corporate governance. However, it seems that corporate governance principles always give emphasis on the rights and privileges of shareholders. In addition, the principles of corporate governance clearly point out the role and responsibilities of the board, firm’s integrity and ethical behaviour, and concerns of disclosure and transparency. The corporate governance practices are largely different across the globe. As Vasilescu (2008) points out, the Continental Europe’s multi-stakeholder model gives first priority to the interests of workers, customers, managers, and suppliers whereas the Anglo-American corporate governance model mainly recognises the interests of shareholders. Continental European countries like Germany and Holland possess two-tiered Board of Directors with intent to improve their corporate governance practices. The main point of difference in corporate difference between United Kingdom and United States is that in UK, the CEO generally does not hold the chairmanship of the board whereas in US, the CEO also serves as the Chairman of Board. Corporate governance in UK In the opinion of Roberts (2011), the balance of power between the board of directors and the general meeting primarily constitutes corporate governance of a UK company. Generally, the term “governance” is used to refer to principles mentioned in the UK Corporate Governance Code. As cited in Harbottle and Lewis (2010), the UK Corporate Governance Code 2010 is a set of corporate governance principles which aim the improved performance of the listed companies on the London Stock Exchange. Financial Service Authority’s Listing Rules demand the public listed companies to disclose how they have abided by the proposed code and explain where and why they have ignored the rule. Private companies are also encouraged to follow these corporate governance guidelines even though it is not a compulsory requirement in private firm accounts. This Code contains a principles-based approach and a rules-based approach; the former provides strategies for best practice while the latter rigidly defines exact practices that have to be adhered to. The recently issued UK Corporate Governance Code 2010 provides specific guidelines regarding appointment and remuneration of directors. As Keasey, Thompson and Wright (1997, pp.274-275) note, the Code stipulates that NEDs should oversee appointments committee and recommends a ‘performance related pay’ as director remuneration instead of a ‘say on pay’ by the general meeting. Under accountability and audit section, the Code gives more emphasis on the context of recent corporate scandals and directs that the audit committee must be composed of independent non-executive directors only. As per the provisions of this Code, the current UK corporate strategy maintains good relationship with shareholders and keeps them well informed on organisational affairs. Finally, the recently formed guidelines set out specific practices for treating institutional shareholders who constitute a unique part of the UK financial market structure. Functions of financial management Financial planning, financial control, and financial decision making are the three major functions of financial management. Financial planning is vital for every management to ensure that sufficient funds are available to meet day to day needs of the business. Generally, managements plan for financing short term, middle term, and long term objectives. Short term funds are used to pay employee salaries and invest in stocks, whereas middle term and long term funds are employed to further strengthen the productive capacity of the business. The financial management uses the tool of financial control to make certain that business properly meets its prefixed goals. In addition, this tool assists organizations to determine how much to invest in short term business operations and how to raise the needed funds. Investment, financing, and dividends are some of the primary aspects of financial decision making, which attempts to retain the profits earned by the business. The economic environment of an organisation greatly affects the functions of the financial management. To illustrate, organisations operating with scarcity of funds cannot allot much for investment purposes or other productive purposes. In contrast, financially stable firms can effectively carry out their finance management functions without any limitation as they have the potential to raise funds whenever they need. Corporate governance plays an inevitable role in ensuring fair financial reporting process as this concept has set specific strategies and procedures for this process. Since financial management is the backbone any organisation, effective corporate governance practices are essential to make sure that financial policies and operations of a company are potential enough to meet the long term objectives of the concern. In total, corporate governance strategies have a considerable role to play in determining how effectively the financial management functions are carried out. Management of working capital Working capital management is a complex process by which a company ensures that it maintains sufficient cash inflows in order to meet its short term debt obligations as well as operating expenses. In other words, the system of working capital management maintains relationship between a firm’s current assets and its current liabilities. An implementation of an effective working capital management system will certainly assist a company to improve its earnings. Ratio analysis and management of separate elements of working capital are two major aspects of working capital management. Ratio analysis is a very helpful tool for organisations to deal with cash management, inventory management, and accounts receivable and payable management. In addition, inventory ratio, working capital ratio, and the collection ratio are the key ratios that determine the performance effectiveness of working capital management. Every organisation gives great emphasis on working capital management as ineffective use of working capital may end up in net losses. Since the management of working capital is crucial for companies irrespective of their size and nature, corporate governance strategies are inevitable to properly deal with the working capital spending. An effective corporate governance policy can assist firms to design a specific framework for working capital management; therefore, such a policy is beneficial for companies to get rid of the troubles associated with the process of floating capital management. In short, corporate governance is essential to ensure flawless appropriation of working capital and thereby to ensure sustainable growth of the organisation. Investment appraisals Successful companies are always looking for potential investment opportunities as they strive to find ways in which they can develop. According to Jacobs (2008), the top management is forced to deal with a number of different investment proposals, ranging from the development of a new product to introducing the company subsidiary in a new part of the globe. Even most successful companies would not have enough resources to finance all the identified investment proposals, and lenders and other external investors may not be ready to invest huge amounts. Therefore, it is necessary for the management to decide which investment proposal will be the most potential one or which one will make the company more productive. Management experts opine that well structured corporate governance strategies can have a great influence on performing effective investment appraisals. Such strategies assist an organisation to analyse with the company’s long term objectives, the risk elements related with the proposals, and the availability of necessary resources the extent to which the investment proposals are potential. Generally, top managements mainly follow the discounted cash flow method to evaluate the rate of return on the proposed investment and thereby to accept or reject a proposal. However, it is not a comprehensive method as it only considers time value of money and not other factors like management strength, which is needed to take advantages of that opportunity. In contrast, the corporate governance policies greatly assist the senior management to assess whether an investment proposal would add value to the profitability of the company. Sources of capital The sources of capital can be broadly classified into three categories, mainly long term, medium term, and short term capital. Long term capital is used for purposes lasting over seven years while medium term capital is acquired for a period between two and seven years. In contrast, the short term capital is used for financing projects or programs that would be completed within a time period of two years. As Timimi (2010) says, bank overdraft, trade credit, deferred expenses, and factoring are some of the sources of short term capital while medium term capital can be acquired by means of term loans, leasing, and hire purchases. At the same time, long term capital is accumulated from share capital, surpluses, mortgage loan, debenture, venture capital, and project finance. Although long term capital may greatly add value to the productivity of a firm, it is very difficult to accumulate such funds as they involve huge expenses. In contrast, organisations can easily raise short term capital with minimum expenses; but, the benefits derived from these funds will be smaller as compared to other means of financing. Therefore, a firm must critically analyse different aspects of a project or investment while choosing the type of capital required financing that particular project. Corporate practices reveal that corporate governance strategies aid organisations to decide the most potential sources of capital that would greatly meet the requirements of the project. Since corporate governance system frames specific rules for project financing, managements can easily evaluate the potentiality of different capital sources in funding a particular project by taking cost and value of the capital source into account. Treasury risk management techniques Treasury management is a complex process by which a firm attempts to maintain its holdings economically with the ultimate objective of liquidity maximisation and mitigation of operational as well as financial risks. Nowadays, organisations widely apply ranges of treasury risk management techniques in order to stabilise the business growth and thereby to meet the interests of its shareholders. Treasury policies and planning and reporting structures are the key elements of the treasury risk management framework. Birts (2001, p.46) states that treasury operating plan (TOP) greatly assists the treasury management to ensure that firm’s strategies and operations are in line with the short term as well as medium term goals of the management. Hedging is a major tool of treasury management that assists a firm to eliminate risk elements associated with unforeseen market changes to a great extent. The survivors of the 2008 global financial crisis including India, China, and some other Middle East countries had effectively applied the tools of treasury risk management. While analysing the economic background of the global crisis survivors, it seems that they had followed effective corporate governance strategies too. Hence, it can be undoubtedly stated that well designed corporate governance practices can have a noticeable influence on an organisation’s treasury risk management. Since many of the industrially developed countries presently strive to maintain a healthy inflation rate, regulators strongly recommend the establishment of a well planned corporate governance approach. Global approach to corporate governance As discussed earlier, corporate scandals during the last decade have influenced companies to think about the need of a global approach to regulate corporate governance. Many economists also recommend this move towards global corporate governance approach. They argue that the process of globalisation integrated different cultures into an international economy and it enhanced international trade, direct foreign investment, migration, and technology sharing. In addition, the concept of globalisation has greatly contributed to effective and rapid circulation of ideas, languages, and cultural ideologies. Economists also realised that the concept of globalisation would contribute to the rapid economic restructuring of the global economic condition. Therefore, a group of economists claim that a comprehensive global approach to corporate governance would produce far reaching benefits to multi-national corporations. However, the above discussion points to the fact that a global approach towards corporate governance would not benefit organisations to take maximum advantages of the available opportunities. It is evident that micro as well as macro environments of an organisation will vary from country to country. In addition, different countries possess different political landscapes and cultural statuses. Under such circumstances, a global corporate strategy would not be appropriate for many countries, especially for underdeveloped countries. As a result, multinational corporations need to follow distinct corporate governance strategies so as to fit their business interests with the economic as well as political framework of separate countries in which they have business roots. Wharton management professor Mauro Guillen (2002) strongly recommends that different countries must practice their own corporate strategies rather than adapting to a global corporate approach. He points out that the concept of globalisation has encouraged and benefited countries differently and nowadays many countries are planning a deglobalisation process (ibid). Moreover, the globalisation process further worsened the economic situation of underdeveloped countries. To illustrate, Bhorat and Westhuizen (n.d) report that the African economy’s annual growth was only 2% between the period 1984 and 1993; and this growth rate was not even enough to meet the increasing population needs. In order to stop poverty from worsening, Africa should have achieved annual growth rate of 5%. Similarly, most Asian countries were underdeveloped in the beginning of 1990s. While analysing the economic landscape of Latin America, it is clear that this region is still dependant on western economies. In addition, Latin American countries largely depend on capital inflows from industrialised countries since external debt is still beyond the limits in this region. Based on these evidences, Guillen (2002) strongly suggests that companies must look for a distinctive way to fix their position in international market rather than converging to a global model. It is obvious that sources of capital and labour, level of technical expertise and employee productivity, and degree of competency will be different from organisation to organisation and from country to country. Hence, such firms or countries need to apply distinct corporate strategies in production, distribution, and promotion in order to effectively confront with stiff global market competition. Likewise, a global corporate policy will not better serve the interests of firms as each firm markets its own products and services. Korean auto manufactures can be taken as example. Their finance strategy is to obtain maximum money within a short period of time as they have planned to sell more low cost cars. In order to achieve this objective, they exceedingly depend on borrowings, particularly bank loans. Consequently, Korean auto manufacturers’ corporate governance structure constitutes a mutual relationship with government, for which the government has an influence on the companies though banks and the auto manufacturing companies have a say in government issues. Such a corporate governance framework would not be applicable in Chinese automobiles industry since Chinese government does not encourage too much borrowing. “French corporate governance is another prime example of the effectiveness of different strategies” (Guillen, 2002). He reflects that French corporate governance approach often involves “an intricate network of public agencies, large firms, and banks” (ibid). Although such a system greatly benefits the French economy, it is not advisable for majority of other economies. Therefore, every organisation has to frame separate corporate governance approaches after considering different aspects of the country in which it operates. Likewise, the corporate governance structure of a country is connected with many sectors of the economy including labour laws, tax laws, and bankruptcy legislation. Hence, a corporate governance restructuring process necessitates an overall change of the economy; otherwise, this strategic movement will certainly cause troubles to the economy. From this, it is clear that a nation needs to take efforts to adapt to a global approach to regulate corporate governance. In the same way, underdeveloped countries cannot easily cop up with a sudden change in corporate governance strategies. In addition, many of the economists hold the view that a global corporate approach will help developed countries to unduly impose their influences on economically backward countries. In short, such an approach will not be adequate enough to establish an integrated global economy or it may not benefit the whole world equally. Therefore, it is advisable for countries to maintain their own corporate governance structure and make timely additions to it. Conclusion From the above discussion, it is evident that a global approach to regulate corporate governance will not benefit multinational companies, because economic as well as political aspects differ from one country to the other. The globalisation, which aimed the integration of the whole world economy, caused far reaching troubles to many economies. Based on empirical evidences, economists suggest that a global corporate governance structure will not be beneficial for multinational corporations as they do not get similar micro as well as macro environments in all countries. References Birts, AN 2001, Balance Sheet Structures: International Treasury Management Series, Woodhead Publishing, England. Bhorat, H & Westhuizen, CV n.d, ‘Economic growth, poverty and inequality in South Africa: The first decade of democracy’, pp.1-42, Viewed 27 November 2011, Guillen, M 2002, ‘A global view of corporate governance: One size doesn’t fit all’, Knowledge @ Wharton, Viewed 27 November 2011, Harbottle & Lewis 2010, ‘Corporate governance for smaller AIM companies’, Viewed 27 November 2011, Jacobs, DF 2008, ‘A review of capital budgeting practices’, IMF Working Paper, pp.1-24, Viewed 27 November 2011, Keasey, K, Thompson, S & Wright, M 1997, Corporate Governance: Economic, Management, and Financial Issues, Oxford University Press, New York. 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