The Investment Capital for Corporate Businesses - Term Paper Example

Essay The equity market is a major source of investment capital for corporate businesses seeking to finance both new and existing investment initiatives. From your point of view as the Chief Finance Officer for a Multinational Corporation based in an emerging market economy, discuss the role of the stock market as a transmission mechanism for foreign direct investment capital inflows into the emerging economy. Introduction Over the last few years, the financial markets especially the stock markets have grown significantly in the emerging economies. Stock markets are considered as one of the primary sources to raise money for the companies. The higher liquidity of securities in this market appears as one of the major reasons which have made stock markets as major choice of investors as compared to other kinds of investments like real estate investments. The increasing number of multinational companies and open access to foreign investors has further boosted the activities of stock markets in the emerging economies. The aim of this essay is to analyse the role a stock market plays as a transmission mechanism to attract foreign direct investment as capital inflows. Through critical analysis of research findings and opinions of early researchers, the topic has been investigated. Literature Review Both for small and large companies, stock markets appear as a major source of raising capital and these companies further use the capital in the expansion of the organisation. Therefore, by providing liquidity to companies, stock market plays a very significant role in supporting financial systems of companies. The internationalisation of world’s capital markets has enhanced the role of equity markets in encouraging capital inflows. Woepking (2007) argues that internationalisation of capital markets have given opportunity to investors to diversify their risk. Investors like individuals and companies diversify the risks of their portfolios by investing in equity markets of foreign companies. The foreign direct investments capital inflow is increasing in the emerging economies. In 1995, total foreign direct investment to developing economies increased by 38 percent of global FDI and rose to US $95 billion as compared to US $25 billion and 12 percent of global FDI in 1990 (Wilhelms & Witter, 1998). Foreign direct investment as a direct investment is considered very important in modernizing the national economy and its growth (Alfaro, Chanda, Ozcan & Sayek, 2000). Therefore, it is interesting to discuss whether increasing foreign direct investment inflow in the emerging economy is associated with the transmission mechanism of stock market or not. There are two major groups of findings on the relevant topic. One group of researchers have evaluated a positive role of stock market as a transmission mechanism to attract foreign direct investments. The other group of researchers’ support that FDI is a substitute to stock market or stock market cannot play an important role because of less confidence of foreign investors on the capital markets of emerging economies. Stock markets increase the benefit for the investors because their access to information about the firms becomes easy and corporate governance is also improved (Kyle, 1984 and Holmstrom & Tirole, 1993 cited in Nowbutsing & Odit, 2009). Singh and Weisse (1998) studied the role of stock markets in growth of corporate financing in less developed countries and they found a significant impact of stock markets on growing access of corporate finances to organisations. Between 1996 and 2006, the share of foreign investors in the equity market was around 30 percent and in 2005 it was 40 percent because of the increasing interest of the foreign investors towards most liquid segments of investments (Pruski & Szpunar, n.d.). In 2007, Lopez-Duarte and Garcia-Canal conducted a research to determine the stock market’s reaction to foreign direct investments. They studied FDI of listed Spanish companies. The findings of their research show that mode of entry and location of the investment play a very important role between stock market reactions to foreign direct investment. Stock markets play an important role in intermediating funds towards investment projects and the establishment of stock market brought positive structural changes to attract foreign direct investments (Adam & Tweneboah, 2009). With the increasing global interdependence because of geographical diversification of suppliers and demanders, the emerging economies are appearing as the major sources of outward FDI and net exporters of portfolio capital like stocks and bonds etc. Since emerging economies offer promised returns by high growth rates therefore, foreign investors are seeking portfolio capital investments in these economies (Accenture, n.d.). On the other hand, according to the view of Hausmann and Fernandez-Arias, foreign direct investment is a substitute for the development of stock market because aim of foreign direct investment is to overcome the problems which investors face when invests through capital markets (Claessens, Klingebiel & Schmukler, 2001). Therefore, this view highlights a negative correlation between foreign direct investment and development of stock markets. Jang, Kim & Ko (2009) as presented the opinions of various researchers on ability of emerging economies to raise external capital. He highlights that this group of researchers are of the opinion that investors are usually less willing to provide capital to the entrepreneurs in the emerging economies because of the inappropriate protection of property rights and as a result emerging markets usually have small stock markets. Beck et al argue that companies in the emerging economies face poor institutional development and are less dependent on external financing and more dependent on the banks and financial institutions (Beck, 2008 cited in Jang, Kim & Ko, 2009). Based on the view presented by Jang and his colleagues, it can be argued that stock markets in emerging economies do not actually offer a significant transmission mechanism to foreign direct investment capital flow which means that companies operating in these economies might have less access to external financing. Discussion and Analysis Basically stock market is the securities market which can be classified into primary and secondary markets. Through primary markets, corporate organisations issue their securities and raise capital. When the securities are resold in the market, they become the part of secondary markets. Therefore, the businesses in all economies, regardless of their nature as developing, developed or underdeveloped economies, are seeking both new and existing investments through stock markets. There are various methods through which foreign investment flows to emerging economies. Stock markets in emerging economies also appear as one of the transmission mechanisms. The higher liquidity of this market has always attracted the investors both from local and international markets. China has opened the doors for the foreign direct investment for the last 25 years and most of the spending has been seen in labour-intensive and low cost technology projects. When in 2003, China attracted FDI at $30 per capita which was very less as compared to many of the other emerging economies like Brazil which attracted $195 per capita. These concerns of less FDI increased concerns for China and Chinese government worked with OECD to develop new policies for improving business environment in China. One of the policies recommended by OECD to China was to open the stock and bond markets for the foreign-owned companies (Davies, 2003). The foreign companies exploit low labour opportunities in China and focus less on technology-intensive processes. In order to improve the business environment to improve the development of stock markets, OECD has given this recommendation to Chinese government. By opening stock market for foreign-owned companies, emerging economies can boost the capital inflow. Access to foreign stock markets opens new investment opportunities for the foreign investors who want to diversify their risks by choosing alternative investments from different economies. In September 2010, Brazilian state bank reported a foreign direct investment capital inflow of $5.39 billion (Colitt & Costa, 2010). Although the investment flow is from different sources, however, Brazilian stock and bond market also plays an important role in attracting a major chunk of it. The news of higher demand of stocks and bonds for foreign investors in emerging economies as compared to developed economies has become daily news. For example, a recent performance report of JP Morgan Chase & Co.’s CEMBI Index has highlighted that extra yield investors are asking for Brazilian corporate dollar bonds instead of U.S. treasuries (Espinosa & Winterstein, 2010). The foreign capital inflows which are coming to emerging economies through various means such as direct investment in equity markets do have a significant impact on these economies. The increasing capital inflows have increased the dependency of these economies on the developed and industrialised economies. The experience of emerging economies show that process of reversal of external capital flows and decline in currency is riskier for the domestic financial stability of the emerging economy (Akyuz & Cornford, 1999). The idea is that if foreign capital flows through stock markets facilitate the development of stock markets in the developing economies then their reversal at some point in time in future could negatively influence the domestic stability of economy. The increasing capital inflows through stock market have also contributed to the globalisation of financial system. The impact of recent global financial crisis which emerged from developed countries on emerging economies is the result of increasing dependence of capital inflows from these economies to emerging economies. The global financial crisis has further shifted the interest of investors from developed economies to the developing economies. The confidence of the investors and their perspectives on financial security is changing. Stock markets of developing economies appear not only as liquid investments but also appear to offer high growth rates to investors. A recently published report of Foreign Direct Investment Confidence Index highlights that emerging economies have become attractive for foreign investors. Moreover, China, India and Brazil are among the two five emerging economies (Trade Forum Editorial, 2010). The opinion and research findings of the researchers which have found the negative correlation between foreign direct investment and stock market development can be opposed because these researchers had considered FDI as a substitute to development of stock market. However, today, emerging economies are attracting a huge chunk of FDI through portfolio capital. A number of researchers report that investors are not willing to invest in companies by purchasing their stocks in the emerging markets because of lack of confidence and high political and environmental uncertainty. Although the reality of high environmental uncertainty in emerging economies cannot be negated however, as mentioned earlier that the recent global financial crisis has shifted the perspective of the investors on this aspect. As a result the confidence of foreign investors on stock markets of emerging economies has increased. In my opinion, the stock markets of emerging economies might not be very attractive for the foreign investors in the past years; however, the changing business environment, investors’ confidence and economic situation have played an important role in establishing stock market as a transmission mechanism for foreign direct investments in emerging economies. Conclusion In consideration to the literature review and findings of the early researchers and the critical analysis of these findings, it can be concluded that stock markets of emerging economies have significantly become a transmission mechanism to encourage foreign direct investment capital inflows in emerging economies. The higher liquidity, higher returns, increasing multinational companies and change in investors’ confidence are some of the major factors which have enhanced the role of stock markets. Moreover, since foreign direct investments bring huge developments in emerging economies therefore, these economies have indulged in a competition to develop their stock markets to attract more foreign direct investments. Essay 2: The interest rate is commonly referred to as the cost of capital; critically discuss the factors that would cause equity investors in developed countries where low interest rates prevail to seek alternative investments in other emerging market economies where interest rates are reasonably high. Introduction The growing orientation of foreign investors towards the emerging markets has become an important area of investigation for the researchers. One of the reasons which most of the researchers are highlight is that global financial crisis has shifted the focus of the foreign investors. However, it is very important to learn whether increasing capital inflow of foreign investors in the emerging economies is a recent phenomenon or not. In fact there are various factors which can contribute to the shifting behaviour of equity investors of the developed states towards the developing economies. An apparent factor is the interest rate or cost of capital. The interest rate in the developed economies is far lower as compared to the interest rates in the developing economies because of the easy access to debt and credit in the developed economies. The scare availability of debt in the emerging market and the high cost of debt make the emerging markets attractive for the foreign investors. Are these the only two reasons which have changed the perspectives of the equity investors of developed states? In order to analyse the reasons and factors because of which the investors of developed countries are seeking alterative opportunities in the emerging economies, this report has been created. The aim of this report is to analyse the factors which are contributing to the changing perspective of the customers. Moreover, this essay will also highlight the priorities which are important for the investors while seeking investment opportunities. Literature Review The focus of investors of developed countries towards the emerging economies is not an abrupt phenomenon. It is a result of the increasing globalised business environment and foreign investment opportunities. However, the significantly increase in this trend in the recent has attracted the attention of the researchers. It is interesting to note that most of the investors agree on the fact that equity investors are moving towards emerging economies however, their opinions conflict when it comes to discuss the factors which encourage this shift. In the previous years, the developing economies had imposed significant restrictions on capital movements and they had maintained overvalued exchange rates and had set interest rates lower than the inflation rate (Edmunds & Moeller, 1998). Today, the case is opposite as developing economies have eliminated the capital movement restrictions. It is interesting to note that equity investors of developed economies are not looking for equity opportunities in emerging economies rather they are looking for other sort of opportunities such as private infrastructure investments. The dataset of FIAS highlighted that during 1990s, the foreign equity investors participated in more than 80% of all private infrastructure investments in the emerging economies (Sader, 1999). The demand for emerging market instruments is increasing because the developed market investors face lower inflation, lower interest rates and low growth of their equity funds (Choudhry, 2001). Toth and Zemcik (2006) have investigated the panel of Czech firms to analyse the reasons because of which the emerging markets have become attractive for the foreign investors. They have highlighted that foreign-ownership had enhanced the interest of foreign investors in the emerging markets. Their research findings show that lower labour costs and low income corporate taxes are two major attractions in foreign-ownership for the investors in the developed countries. On the other hand, Forbes highlights the reasons because of which investors opt for U.S. assets and securities. These reasons include highly developed, liquid and efficient financial sector of United States; strong corporate governance, standards and institutions; low information costs and familiarity to U.S. financial market; dollar-based U.S. assets; non-correlation of U.S. securities with securities of other economies and certain other advantages which investors enjoy in the U.S. market (Forbes, 2007). The findings of this research are very significant to understand the priorities of investors because of which they seek investment opportunities in any of the state. Discussion and Analysis The table below shows the interest rates in descending order for different countries of the world. It is evident from the table that the developed economies like United States, United Kingdom and many European countries have very low interest rates as compared to the developing economies like India, China, Pakistan, and Venezuela. Country Interest Rate Top of Form CountryBottom of Form Interest Rate Japan 0.00% Israel 1.75% Singapore 0.03% United Arab Emirates 1.80% United States 0.25% Norway 2.00% Switzerland 0.25% Saudi Arabia 2.00% United Kingdom 0.50% South Korea 2.25% Hong Kong 0.50% Malaysia 2.75% Denmark 0.75% Chile 2.75% Czech Republic 0.75% Colombia 3.00% Euro Area 1.00% Peru 3.00% Germany 1.00% New Zealand 3.00% France 1.00% Poland 3.50% Italy 1.00% Mexico 4.50% Spain 1.00% Australia 4.75% Canada 1.00% India 5.25% Netherlands 1.00% Hungary 5.25% Belgium 1.00% China 5.56% Sweden 1.00% Turkey 6.50% Austria 1.00% Indonesia 6.50% Greece 1.00% South Africa 6.50% Finland 1.00% Russia 7.75% Portugal 1.00% Iceland 8.00% Ireland 1.00% Argentina 9.93% Luxembourg 1.00% Brazil 10.75% Slovenia 1.00% Pakistan 13.00% Thailand 1.50% Venezuela 17.98% Source: Trading Economics Equity investors from the developed countries seek different investment opportunities in emerging economies. What are the major factors which insist the equity investors from developed countries where cost of capital is significantly lower, insist these investors to seek different investment opportunities in emerging economies where cost of capital is significantly higher? The factors which Forbes (2007) highlights for the attraction of U.S. market can be evaluated in the case of emerging economies. However, a significant difference can be noticed between developed financial markets (like U.S.) and developing financial markets (like China). Like U.S. financial market, the markets of emerging economies are not that much efficiency however, they are liquid. Although emerging financial markets are adopting international standards and institutions patterns however, they do not have a strong corporate governance structure like a developed market. Information disparity is significantly higher in emerging economies which increase the chances of unfair competitive advantage unlike a developed economy financial market. Moreover, securities of emerging economies also have little or no-correlation with the securities of the other economies. Therefore, the equity investors of developed countries can find good risk diversification opportunities by investing in alternative investment opportunities of emerging economies. The first factor is the higher economic growth rates of the developing economies as compared to the developed economies. Actually, higher economic growth rates promise fare higher returns on the investments of the investors therefore, investors seeking high yield investment tends towards various investments opportunities in emerging markets. According to AT Kearney’s 2007 FDI Confidence Investment Survey, China is the first attractive destination for the foreign investors and China has been leading in this index ranking for the last five years. One of the primary reasons of this ranking is the expanding and growing economy of China. In 2007, China’s growth rate was 11.4 percent and it appeared as the world’s fourth largest economy (People’s Daily Online, 2008). On the other hand, most of the developed economies were facing shrinkage in their GDP growth rates because of the dawn of global financial recession. It’s not only about China but most of the other emerging economies are also attracting the investors because of their growth prospects. Second factor is the availability of cheap resources in the emerging economies. The equity investors when seek investment opportunities in the emerging economies, they usually invest in foreign-owned firms. Through creating these firms they get access to cheap labor and low corporate taxes (as highlighted by Toth and Zemcik in 2006). The U.S. investors and European equity investors look for investment opportunities in China because they find cheap labour and low tax rates. The third factor is the stable investment environment of the emerging economies. Although emerging economies face economic and political risks however, through strong governance and market reforms, they offer stable investment opportunities to the investors. The equity investors consider emerging financial markets more sophisticated as compared to the developed economies markets. For example, entry and exit to Chinese financial market is far easier as compared to any western economy. The other emerging markets are also attracting huge amount of foreign direct investments every year. For example, in a report the growing foreign investments in Indian economy were discussed. The report highlights that many foreign companies are looking for assets in the emerging economies because they find so much growth in this market (Rediff, 2010). Actually, the large investors who have significant equity shares in the huge companies expect to generate more in the growing economies because of the increasing investment opportunities. Their investment growth has become stagnant in the developed economies because of the increasing competition and low cost availability of debt. The fourth factor is the lower concerns of emerging economies on debt burdens as compared to the developed economies. In the developed economies, the concerns on increasing sovereign debt are considered very strictly which lead the investors to consider their own prospects. The fifth factor is the scarce availability of debt in the emerging economies which made these markets for the foreign investors. Because of the less availability of debt in emerging economies, the higher cost of capital is paid to the investors, as it is evident from the higher interest rates in these economies. To achieve higher returns on their investments, the investors opt for these markets as the ideal markets to invest in. As pointed out by Edmunds & Moeller (1998) developing economies had imposed capital movement restrictions by keeping the domestic interest rates lower than inflation rate. Today, these economies are encouraging capital inflows because they are aware of the growth and development prospective which these investments can provide to them. Today, emerging economies have kept these interest rates higher than inflation rates to promote capital movements. Finally, risk diversification is another factor which can encourage the equity investors of the developed countries to seek alternative investment opportunities in the emerging economies. The variations in foreign direct investments in different sectors of the emerging economies are also notable. These variations show that when global investors focus on emerging economies, they do not only tend to diversify their risks but they also seek to achieve the highest yield rates by investing in more growing sectors and industries. Conclusion Based on the discussion and analysis of the early literature and findings, it can be concluded that equity investors of the developed countries are exploring investment opportunities in the emerging economies. The major reason for this shift is the high cost of capital in the emerging economies which allow them to achieve better yields. In addition, there are various other factors which are also encouraging these investors to explore the emerging markets. Although emerging markets do not have efficient financial markets nor they have efficient corporate governance however, the growing economy, the access to cheap resources, the diversification of risk, the unexplored market segments, long term growth prospects and the improving business environment are some of the major attractions for the foreign investors. These factors along with the better returns insist the equity investors of the developed economies to seek better opportunities in the emerging markets. Bibliography for Essay 1 Accenture, n.d. Flow of Capital. [Online] Available at: EuroJournals https://microsite.accenture.com/mpw/concepts/Pages/FlowOfCapital.aspx [Accessed 8 November 2010]. Adam, M. A. & Tweneboah, 2009. Foreign Direct Investment and Stock Market Development: Ghana’s Evidence. International Research Journal of Finance and Economics. [Online] Available at: EuroJournals http://www.eurojournals.com/irjfe_26_15.pdf [Accessed 7 November 2010]. Akyuz, Y., & Cornford, A., 1999. Capital Flows to Developing Countries and the Reform of the International Financial System. [Online] Available at: http://www.unctad.org/en/docs/dp_143.en.pdf [Accessed 8 November 2010]. Alfaro, L., Chanda, A., Ozcan K. S., & Sayek, S., 2000. FDI and Economic Growth: The Role of Local Financial Markets. [Online] Available at: EuroJournals http://www.people.hbs.edu/lalfaro/fdipaper25.pdf [Accessed 7 November 2010]. Claessens, S., Klingebiel, D., & Schmukler, L. S., 2001. FDI and Stock Market Development: Complements or Substitutes. [Online] Available at: http://www.iadb.org/res/publications/pubfiles/pubs-fdi-4.pdf [Accessed 7 November 2010]. Colitt & Costa, 2010. Update 2 Brazil Sept Current Account Gap Widens. FDI Up. [Online] Available at: http://www.bestgrowthstock.com/stock-market-news/2010/10/25/update-2-brazil-sept-current-account-gap-widens-fdi-up/ [Accessed 8 November 2010]. Davies, K., 2003. Reforms Could Boost China’s Ability to Attract Foreign Investment. [Online] Available at: http://www.oecd.org/document/8/0,3343,en_21571361_44315115_3240968_1_1_1_1,00.html [Accessed 8 November 2010]. Espinosa & Winterstein, 2010. Panamericano Beats Itau in Bond Market on Upgrade Speculation. [Online] Available at: http://brasilstocks.com/panamericano-beats-itau-in-bond-market-on-upgrade-speculation [Accessed 8 November 2010]. Jang, H., Kim, W., & Ko, Y., 2009. New Equity Issues in Emerging Economy: Do They Lead to Real Investments? [Online] Available at: http://www.ccfr.org.cn/cicf2010/papers/20091214145855.pdf [Accessed 8 November 2010]. Lopez-Duarte, C., & Garcia-Canal, E., 2007. Stock market reaction to foreign direct investments: Interaction between entry mode and FDI attributes. Management International Review. 47 (3), 393-422. Nowbutsing, M. B., & Odit, P. M. 2009. Stock Market Development and Economic Growth: The Case of Mauritius. [Online] Available at: http://www.cluteinstitute-onlinejournals.com/PDFs/1660.pdf 33[Accessed 7 November 2010]. Pruski, J., & Szpunar, P., n.d. Capital Flows and Their Implications for Monetary and Financial Stability: The Experience of Poland. [Online] Available at: http://www.bis.org/publ/bppdf/bispap44u.pdf [Accessed 8 November 2010]. Singh, A., & Weisse, A. B., 1998. Emerging Stock Markets, Portfolio Capital Flows and Long Term Economic Growth: Micro and Macroeconomic Perspectives. World Development. 26 (4), 607-622. Trade Forum Editorial, 2010. New World Order: Shifting Markets in Trade, Investment and Opportunity. [Online] Available at: http://www.tradeforum.org/news/fullstory.php/aid/1587/New_World_Order:_Shifting_Markets_in_Trade,_Investment_and_Opportunity.html [Accessed 8 November 2010]. Wilhelms, K. S. S., & Witter, S. D. M., 1998. Foreign Direct Investment and its Determinants in Emerging Economies. [Online] Available at: http://pdf.dec.org/pdf_docs/Pnacf325.pdf [Accessed 7 November 2010]. Woepking, J., 2007. International Capital Markets and their Importance. [Online] Available at: http://www.uiowa.edu/ifdebook/ebook2/contents/part3-II.shtml [Accessed 7 November 2010]. Bibliography for Essay 2 Choudhry, M., 2001. The Bond and Money Markets: Strategy, Trading, Analysis. Butterworth-Heinemann. Pg. 1059 Edmunds, C. J., & Moeller, E. S., 1998. International Equity Returns, Country Growth and World Economic Recovery. Management International, [Online]. 28 (1), Available at: Springer http://www.jstor.org/pss/40227871 [Accessed 9 November 2010]. Forbes, K., 2007. Global Imbalances: A Source of Strength or Weakness? [Online] Available at: http://web.mit.edu/~kjforbes/www/Papers/Global%20Imbalances-StrengthOrWeakness-CatoJournal-revised-4-11-07.pdf [Accessed 9 November 2010]. People’s Daily Online, 2008. China Most Attractive to Foreign Investors. [Online] Available at: http://english.peopledaily.com.cn/90001/90780/91344/6382157.html [Accessed 10 November 2010]. Rediff, 2010. India is Becoming very Attractive for Foreign Investors. [Online] Available at: http://business.rediff.com/interview/2010/aug/03/inter-india-is-becoming-very-attractive-for-foreign-investors.htm [Accessed 10 November 2010]. Sader, F., 1999. Attracting Foreign Direct Investment Into Infrastructure: Why is it so Difficult. [Online] Available at: http://www.eicontractors.de/doc/fi/eic_document_fi_0006.pdf [Accessed 8 November 2010]. Toth, P., & Zemcik, P., 2006 What Makes Firms in Emerging Markets Attractive to Foreign Investors? Micro evidence from the Czech Republic. [Online] Available at: http://www.eicontractors.de/doc/fi/eic_document_fi_0006.pdf [Accessed 8 November 2010]. Tradingeconomics, n.d. Trading Economics. [Online] Available at: http://www.tradingeconomics.com/World-Economy/Maps.aspx [Accessed 8 November 2010]. Read More