Foreign Investment Decisions - Optimization of ROI in Equity and Bond Markets - Literature review Example

Foreign Investment Decisions – Optimization of ROI in Equity and Bond Markets Introduction: Multinational Corporations (MNCs) have mainly developed with increasing foreign direct investments occurring in the past. The growth of the MNCs can be attributed to different factors like the availability of raw materials in different foreign markets, integration of different operations of manufacturing products and their delivery across boundaries, with secrecy being more protected with direct investing that licensing, as well as intending to obtain greater profits with venturing out the business to different countries. Foreign direct investments have been developed to avoid regulations on insurances and reserve that also prove to be beneficial for businesses. Facilities for production have also become flexible with FDIs, leading to the growth of MNCs (Levi, 2009). Some of the issues encountered by MNCs include juridical problems related with laws, and taxation; status problems; problems as a legal entity; problems with its characteristics, management and transfer pricing; problems with international economy and politics, these involving factors like risks with exchange rates; and differences in the historical backgrounds of different countries thus creating cultural and ethical differences and problems for the MNCs (Sumontoro, 1984). The present study focuses on different issues including globalization strategy, exchange rates and risks, country exposure risks, international market, taxation that are encountered by MNCs, along with discussion of the differences of risks and benefits for MNCs. Issues Encountered by MNCs: MNCs, conducting their businesses across different countries, and with FDIs being strongly involved, have increased their operations in the recent times. However, with such operations increased, there are certain business issues that are also encountered by the MNCs as will be discussed in this section of the study. Globalization Strategy: MNCs performing at a global scale need to consider and plan strategies to make their businesses global. It has been observed in general that MNCs mostly concentrate their operations and sales in their home countries thus being more oriented towards regional rather than international business. In such a situation, global staffing is one of the major issues encountered by MNCs. Global strategies require quality staff to coordinate business plans and objectives globally. Lack of international management leads to failure in being competent to manage the markets that are culturally and geographically distant and different (Collings and Wood, 2009). For an MNC the global strategies of the company in most cases are based on standardization that is associated with the economies of scale and the scope of the business across boundaries. This however affects the local operations of the company since the operations across different countries vary to a great extent. The legal and social environments of working for the company’s employees at the local regions are always different from their foreign auxiliaries companies. Moreover, cultural differences cause a major problem in developing the globalization strategies since it becomes difficult for the employees to adjust to new and different cultures with ease. Even the compensations of the working employees need to consider advantages and disadvantages for the employees because the problem faced is that the strategies are never the ideal ones for them. Thus globalization strategy leading to different policies for recruitment, performance management and compensations lead to problems when in particular the employees are from different countries, cultures and backgrounds, thereby concerning the organization to ensure that strategies are personalized to satisfy the staffs separately (Newlands and Hooper, 2009). Exchange Rates and Risks: MNCs have their objectives to present new products and services to their customers across the globe, and lead the market gaining profits in the foreign markets. However in achieving all these objectives, MNCs tend to encounter several issues and challenges. One of the major challenges faced by the MNCs is the changes and fluctuations in rates of exchange currencies. Such fluctuations lead to unstable profit gains for the company thus proving to be losses for the MNC. The risks that are primarily associated with exchange currencies include the translation or accounting risks, transaction risk, and economic risk (Menon and Viswanathan, 2005). Translation risks are associated with the changes that are reflected on the balance sheet of the parent company, as a result of fluctuating rates of exchange. When a certain rate of exchange brings changes in the transactions denominated by foreign currencies that have been used and declared by the MNC, then it is considered as the translation risk. Thus an amount that has been settled during an agreement may not be the same when the amount is received in actual, affecting the company’s flow of cash. Economic risks refer to the changes occurring in the value of the company resulting from changes in the rates of exchange. For the purpose of minimizing these risks, MNCs make use of financial instruments land derivatives such as forward and option contracts, and currency swaps that can be used to reduce the effects of such changes in the exchange rates. The negative effects on the cash flows of the company are the most severe issues faced by MNCs in regard to exchange rates and risks (Menon and Viswanathan, 2005). Country Exposure Risk: Exposure of MNCs to country risks arise with their increasing investments in developing countries. Such investments are in most cases large investments allowing the MNCs to encounter policy risks and weak legal systems in the country that they operating. Country risks or the risks of investments considering the changes in business environment, lead to reduction of the foreign direct investments. As a result, the MNCs tend to lower their stakes of equity trying to reduce the risks (Feinberg and Gupta, 2006). Country risks for MNCs do not only include the political risks prevalent in a country, but it also includes the risks of strikes and rebellions associated with the business (Petrovic and Stankovic, 2009). Country risks for MNCs generally take place in two different forms - one being the risk of sovereignty, and the other being the risk of transfer or convertibility. Sovereignty risks refer to the risks that result from expropriation and restrictions in profits. Transfer risks arise when financial funds in local currencies are not being able to be converted to foreign currencies by the central bank of the country. Through such risks the investors of a company are severely affected, particularly affecting those who invest in economies of transactions. Investments can be considered to be stable in countries that represent stable economic conditions and having favorable business and market conditions for the investors. FDIs in association with country risks are affected since the factors of limitations include barriers to trades, labor market, vertical integration, life cycle of products, as well as services for diversifying the shareholders (Petrovic and Stankovic, 2009). Issues with International Market for MNCs: MNCs are required to perform both in their home countries as well as in other countries where they want to expand and hence globalize. Considering the international market, the most important issue faced by MNCs is the corporate responsibility of the organization and the policies that the company follows in association with this responsibility. However since the performances are global in nature and several international factors are needed to be considered, there are pressures from the international markets that are faced by the MNCs. With globalization of the economy in the international market, the expectations of the politics and the stakeholders of the company vary requiring effective negotiations for the management of global operations that create major challenges for the MNCs (Prakash and Griffin, 2012). Considering the international market, MNCs have to adapt to different cultures and local customers of the countries where they intend to expand their businesses. These also include the traditions and beliefs that are different in different countries and hence the business markets also vary from country to country, creating challenges for the parent company and its employees to adjust effectively. Often there activist groups as well that create oppositions for the MNCs to operate successfully requiring negotiations in the process. Thus there arise pressures of both localization and globalization for the MNCs expanding across boundaries, increasing the importance of social responsibility. Moreover if the states and their institutions are ineffective, then it leads to greater problems for the MNCs to balance their CSR activities focusing both on localization and internationalization. Pressures from politics and the society belonging to different markets also pose problems for MNCs to perform effectively (Prakash and Griffin, 2012). Taxation Issues: Transfer pricing is one of the major taxation issues encountered by MNCs performing across borders. Since MNCs perform their activities of businesses in more than one country thus when purchases or sales of goods take place in one country the effects of the transactions are reflected on other countries as well, since the operations are interconnected. MNCs in such situations are encountered with problems of making the right decisions of allocations of the costs of production and sales of the products and the resultant profits earned by the company. When the business transactions occur within the inter groups, the market forces are different than that of the organizations that are independent. Thus when such transactions occur across the boundaries, the costs and profits that are declared are often lowered or raised in an artificial manner which becomes a problem for the company and its records. Taxation issues for the MNCs are basically associated with the politics prevalent in the respective countries where the business has to operate. Minimization of costs and maximization of profits are the primary intentions of the tax authorities. Companies on the other hand focus on minimizing their payments of taxes on an international basis (McNair, Dottey and Cobham, 2010). Other Issues: Cultural problems are the most common and major problems encountered by MNCs particularly when the company initially sets up its business and expands across boundaries. With business activities needed to be performed in different countries, the organizational employees face difficulties in adjusting with the difference in cultures and the new cultural environments that they have to work in which takes them a lot of time to plan and adjust themselves for effective and efficient performances (Baumuller, 2007). Ethical issues are also faced by MNCs while working in different markets. This considers part of the social responsibility that today’s business organizations are more concerned with in order to sustain competitive advantages. With MNCs working globally, there is a global dependency among the business counterparts and there are greater expectations from the international managers in terms of their social and ethical responsibilities that naturally increase the challenges for the companies (Mehalu and Ababa, 2011). Differences between the Risks and Benefits for MNCs and Their Domestic Counterparts: There are both risks and benefits for MNCs and their domestic counterparts. However there are certain differences that can be obtained in regard to the risks and benefits as obtained for MNCs and for their domestic counterparts. Considering the risks associated with MNCs and their domestic counterparts the following studies could be obtained (Shapiro, 2008): If stock portfolios are prepared for both MNCs and their domestic counterparts, the rates of returns are normally identical in terms of their statistics, thus shareholders having the same portions of returns (Shapiro, 2008); However the level of fluctuations for the stock portfolio of the MNCs is less than that of their domestic counterparts (Shapiro, 2008); Also the betas for the MNCs are more stable than that of the domestic counterparts and reflect lower values. This indicates that increasing diversity reduces the systematic risks for the company that is obtained more for the MNCs thus reflecting higher risks for the domestic counterparts (Shapiro, 2008). Likewise, the benefits for the MNCs and for their domestic counterparts also reflect certain differences that are listed below (The Multinational Corporation, n.d.): An MNC has the facility to divide its value chain in different countries and locations across the globe which is not possible for their domestic counterparts (The Multinational Corporation, n.d.); The different operations, including manufacturing, research & development can be located to different locations depending on the advantages while for their domestic counterparts the operations are restricted only to the home country (The Multinational Corporation, n.d.); Global presence of the MNCs also provides them greater exposure to new ideas and advancements which is not possible for their domestic counterparts to achieve (The Multinational Corporation, n.d.). Conclusion: From the above study it could be obtained that since MNCs have to perform their acts of businesses across boundaries, there are several factors that they need to consider, leading to several issues or challenges for the businesses. With differences in cultures, exchange rates, market environments, and the need for globalization strategies meeting all such differences, the challenges for MNCs are huge. However, there are both risks and benefits of the MNCs that also reflect greater advantages of their globalized businesses over their domestic counterparts. References Baumuller, M. (2007). Managing Cultural Diversity: An Empirical Examination of Cultural Networks and Organizational Structures As Governance Mechanisms in Multinational Corporations. Switzerland: Peter Lang. Collings, D.G. and G. Wood (2009). Human Resource Management: A Critical Approach. New Jersey: Taylor & Francis. Feinberg, S.E. and A.K. Gupta (2006). 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