How Globalization Has Changed MNCs Financial Management - Research Paper Example

How Globalization has Changed MNCs Financial Management Contents Introduction 3 2. Research Objective 3 3. International Financial Management 4 3.1. How the Financial Management of MNCS is different 5 3.1.1. Foreign Exchange Rates 5 3.1.2. Political Consideration 5 3.1.3. Expanded Opportunities 6 3.1.4. Market Imperfections 6 3.2. Nature and Scope of Financial Management of MNCs 6 3.3. Influence of Globalization on Capital Market 7 3.3.1. Effects on Banking System 7 3.3.2. Portfolio Diversification and Emergence of the Single Global Financial System 7 3.3.3. Intervention of Non-banking Financial Institutions 8 3.3.4. Broadening of Capital Markets 8 3.4. Globalization and Risks Management of MNCs 8 3.4.1. Translational Risk 8 3.4.2. Transactional Risks 9 3.4.3. Economic Exposure 9 4. Conclusion 10 Works Cited 11 Name of the Student Name of the Professor Course Number Date 1. Introduction Globalization is the process that has facilitated the cultural, economic, political as well as demographic assimilation among the countries around the globe. Such integration has also accelerated the process of cross border trade and exchange of goods and services. Therefore, globalization and international trade has also modified the traditional concept of financial management to a great extent. Big corporate has started operating in multiple economies in order to capture business opportunities in those markets where the cost of production is comparatively lower (Anbarasu 259). In this way, profit maximization of all such companies is ensured. For instance, United States evolved as a big exporter of aircraft, software, wheat etc to the countries such as China, Britain, India and France. In exchange, the economy started importing crude oil from OPEC countries, wines from France, garments from China and many more. Such interdependence among global countries has changed the pattern of consumption and investment functions of the individual economies as well. Consequently the financial markets are also becoming highly integrated as inward shift of foreign capital and foreign direct investment has become many prominent in various countries. This is reflected in the capital market and foreign exchange market of different countries. This can be exemplified by showing the Toyota’s venture in China which is partially financed by American investors who purchase Toyota shares traded on the New York Stock Exchange. However, as a result of operating globally, criticality in business has also increased. Companies operating globally are highly exposed to translational and transactional risks arising out of differences in foreign exchange rates. 2. Research Objective From the above discussion it is evident that as a result of rapid expansion of globalization the functionalities of multinational companies has been transformed in such a way that has compelled the companies to transform their procedure of financial management to the universal standard. Therefore, the main objective of the research is to identify how globalization has influenced and changed the financial management of multinational companies. For the purpose of analysis, the transformation in the capital and foreign exchange market which has influenced the MNCs to modify their financial management will be highlighted. How such companies mitigate financial risks in international context and bring financial stability in broader aspect will also be examined. The research will be based on qualitative data derived from various secondary sources such as books on international financial management, newspaper reports and articles published in The Wall Street Journal and other research papers from eminent scholars. 3. International Financial Management Rapid liberalization of economies as well as expansion of international trade and investment has exposed immense opportunities to the multinational companies. Such expansion has been possible mainly because of the possibility of technology transfer, foreign direct investments and advancements in communication and transportation system. However, in order to restrict unethical practices in international trade (such as, dumping) and to protect the interest of all the developing and developed countries across world, the global business performances of the MNC’s are closely monitored by international organizations such as WTO (World Trade Organization), NAFTA (North American Free Trade Agreement), EU (European Union) and many more. Though all such organizations have sufficiently loosened the trade barriers and other restrictions imposed upon cross-border trade, they have also defined the ultimate goal of international operations for the MNCs i.e. to maximize shareholder’s wealth. Naturally, such objective drives the multinational companies to take opportunities of market imperfections and maximize their individual profits. Moreover, privatization has placed a new demand on international capital markets to finance the purchase of the former state enterprises, and it has also brought about a demand for new managers with international business skills. In fact, in this era of modernization practices are very common among multinational companies where they tend to produce products and services in one country which is financed by the capital raised by another country or multiple countries through issuance of securities to the foreign investors and by selling finished merchandises in that country as well as in other countries (Brigham & Houston 453). 3.1. How the Financial Management of MNCS is different The financial management of MNCs are distinct as compared to the domestic companies because of the influences of many international drivers and attributes on the operations of such companies. These factors are: 3.1.1. Foreign Exchange Rates As the foreign exchange rates differs among different countries due to currency differential, companies operating in the international framework tends to establish business in the countries where the value of currency is comparatively low. Such decision reduces the cost of production for the multinational companies and such companies gain sufficiently by selling the end products in those countries where value of currency is higher. In fact, the MNCs also takes the advantage of foreign exchange market through currency hedging i.e. taking equal and opposite position in two different foreign financial markets and gain from squaring off the position from that market in which the position is showing a higher value. However, fluctuation in foreign currency rates, mainly of floating exchange rates raises the financial risk of the MNCs as well. Being operated in a single currency nation, domestic companies are restricted from such international financial opportunities and safeguarded from foreign exchange risks (Coker 146). 3.1.2. Political Consideration Political factors also influence the financial activities of the multinational companies. Changes in legislations in the guest country substantially influence the business performances of the guest company. For instance, the initiative of Indian government to liberalize the economy in 1991 facilitated many foreign companies to establish business and operate profitably through using the cheap labour and other resources of the country. As the multinational companies started extracting huge profits from their Indian subsidiaries, the country witnessed inflow of more and more foreign capital in future. Though such regulations proved to be favourable for the MNCs, incidents are also there where political restrictions and massive trade barriers hurts the financial interests of the MNCs to a great extent. For example, the multinational telecommunications companies operating in Australia such as Ericsson experienced considerable increment in manufacturing costs when the government of Australia made it mandatory for the subsidiary companies to ITT-designed equipments from local companies for manufacturing of end products and services. Prior to the regulation, the MNC used to transfer the technologies and equipments at a cheaper cost from their home country. In order to protect the interest of home country, such political legislations taken by Australian government left an adverse impact in the financial management of the MNC (Shapiro 489). 3.1.3. Expanded Opportunities When the firms grow globally, both the world economy as a whole and the individual firm gets benefitted. MNCs are allowed to raise funds even from more than 7 markets in which the cost of capital is lowest. In fact, such globalization facilitates the firms to reduce reliance on matured markets and invest in emerging nations where the growth possibility is very high because of low cost of capital and availability of huge amount of inexpensive resources which are still unexploited. In this way, the financial motivation of the MNCs from operating globally is served and the emerging nations also gets an access to the foreign capital, their job market expands, enhancing the rate of economic growth. 3.1.4. Market Imperfections The global marketplace is characterised by market imperfections i.e. perfect information is not available to all the market participants. The consumer preferences, tax laws, nature of conducting business as well as cultural prevalence are also different in the different segments of global market. MNCs en-cash the imperfections as an opportunity and tend to engage intro producing highly innovative products and services in order to differentiate the products from their competitors. In this way, the economies get access to the most innovative technologies, products and services and the MNCs become able to maximize their profits through pushing their latest innovations constantly into the markets. 3.2. Nature and Scope of Financial Management of MNCs Due to the effect of globalization, the nature of financial management of the MNCs tends to be distinctive as compared to that of local companies. The financial functions of MNCs are broadly categorized under two sections viz. treasury and control. The functions of treasury managers are structured to analyze the financial position of the firm, to acquire funds from different domestic and foreign sources, taking calculated risk in investment financing and making decisions regarding liquidity and risk management. The control department is responsible for tax planning, managing information system, ensuring budgetary control as well as accounts management. As a result of operating in different nations consisting of different currencies, the financial management of the MNCs becomes critical as the companies deal with a large number of financial instruments and intermediaries. Therefore, expertise in managing finances is reflected by the capabilities of the international finance manager of the MNC to maximize return from investments and ensure low cost of capital. Moreover, as the MNCs are also subjected to experience the capital market volatility, interest rate differentials, requirement of involving expert supervision of international financial managers also holds importance. 3.3. Influence of Globalization on Capital Market The world capital market is highly influenced by globalization and its far-reaching effects. Such effect of globalization on capital market of different countries in turn affects financial performances of the multinational companies. 3.3.1. Effects on Banking System As positive consequences of globalization, the banking system of a large number of countries has gone through reforms and structural modifications. Such transformations have aided the multinational companies to operate successfully in multiple locations without much difficulty in cash transactions and accounts receivables. More importantly, banks tend to move the financial risks, especially the credit risks through off- balance sheet financing into securities market. For instance, capability of the banks to convert a part of the existing assets into tradable securities and yield high risk-adjusted returns through entering into interest rate swaps in international derivative markets makes them an attractive choice for the MNCs for financing their investment activities (Doz & Prahalad 447-468). 3.3.2. Portfolio Diversification and Emergence of the Single Global Financial System The cross-border financial functioning of the MNCs and their inclination towards capturing more shares of the global financial wealth has integrated the financial markets across nations. MNCs strive to maximize their risk adjusted return through diversifying their portfolio internationally and investing in a wide range of national and international industries and currencies. The concept of single global financial system arises to facilitate the multinational companies to gain an access of sovereign debtors and institutional investors under one roof so that the MNCs can choose from wide range of international capital and raise funds as per their own convenience. 3.3.3. Intervention of Non-banking Financial Institutions Along with the prominent presence of banking sector, further intervention of non-banking financial institution drives down the price of financial intermediaries in international financial market. Therefore, the MNCs tend to augment financial instruments from global financial markets where these are available at a competitive rate, rather than acquiring in from the domestic market. Considering the domestic investments, as the rate for financial instruments increase, the individual investors tend to deposit their capital for a longer time in higher-return instruments such as mutual funds. The pool of investments in turn is bypassed by the intermediary to diversify risks of the institutional investors such as multinational corporations. In this way, global capital market strengthens the financial performances of MNCs (Wells 225-287). 3.3.4. Broadening of Capital Markets Effects of globalization has facilitated the banking and financial system across nations to break the traditional functioning of accepting deposits and providing lends and enter into more dynamic responsibilities such as investment banking, pushing insurance, mutual funds etc and asset management. Such efficient effort for diversification of source of revenue and business risks has opened new sources of revenue for the banking sector and enabled to manage issuing of equities and corporate bonds as a source of financing to raise funds from over-the-counter (OTC) derivative markets for their own investment requirements. Such multi-dynamic performances of capital market and advancement of banking sector leaves a positive impact on the financial performances of MNCs (Eun & Resnick). 3.4. Globalization and Risks Management of MNCs Though radical changes in the nature and functioning of the global capital market has aided the global financial system with enormous benefits, changes in the market dynamics has also dragged the MNCs to witness certain kind of risks as a result of operating in international financial market. However, MNCs implement 3.4.1. Translational Risk Translational risk particularly arises for the multinational companies as the companies are engaged into dealing in foreign currencies. The higher the proportion of asset-liability and securities are denominated in foreign currencies in the balance sheet of MNCs, higher is the amount of translational risks for the company. In general, while consolidating the financial statements, the MNCs tend to convert the financial attributes of its subsidiaries into the domestic currency of the company. As the exchange rate among the countries is inherently volatile, translating the inputs of financial statements may appear to be favorable or unfavorable, depending on the current situation of the foreign exchange market. Such transactional risk affects the financial statements and final accounts of the MNC adversely if the ongoing rate in the foreign market becomes higher than the domestic rates. Accounting discrepancies also arise due to such exchange rate differentials. However, multinational companies control and mitigate such translational risks though engaging into balance sheet hedging in international derivatives market. The derivative instrument tends to hedge the assets and liabilities of the MNC denominated in foreign currencies and which are carried at fair value recorded as other income. Such derivative instruments are subjected to nullify balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged. 3.4.2. Transactional Risks Transactional risks are more important for a multinational company as compared to translation risk because this kind of risk directly affects the operating cash flow of such companies. Time differential between entering into a contract and its settlement is the main source for the MNCs to experience this kind of risk. As the time gap increases the probability of this kind of risk affecting the company’s performance also increases. Therefore, treasury department of MNCs try to mitigate this kind of risk through anticipating the future rates of the economy in which the company is planning to sign the contract and accordingly formulate full or partial hedging strategies for safeguarding the company from such risk. Improving liquidity position of the domestic assets also helps MNCs to protect the company from transactional risk because availability of sufficient operating cash flow minimizes the impact of transactional risk to a great extent. 3.4.3. Economic Exposure Multinational companies are affected by economic exposure risk when unanticipated currency fluctuations tend to affect the future cash flows of the company. This type of risk tends to affect the long term business operations as well as market value of the multinational companies; therefore its becomes very important for all such companies to anticipate such risk well in advance, preferably in the time of taking business decisions. Such prediction of future exchange rate conditions should be done by forecasting the future exchange rates of the domestic currency as well as the domestic future exchange rates of the country in which the subsidiary is established. In this way, the risk exposure associated to the foreign currency payables and receivables are hedged and managed efficiently (Wursthorn 435). 4. Conclusion The research paper provides a holistic approach on the effect of globalization on financial management of the multinational companies. As a result of operating in the international financial market, the nature of financial management becomes complex and criticality becomes very high. Though such multinational companies enjoy certain facilities from operating in the global context in terms of expansion opportunities, foreign exchange influences and economies of scale in production and distribution process, the companies also experience translation, transaction, economic exposure and political risk that tend to limit the functioning of MNCs. Therefore, from the above analysis it can be inferred that expertise of the MNCs are relied in their capability of minimizing the risk factors and en-cashing the opportunities available in global marketplace effectively. Works Cited Anbarasu, Joseph. Global Financial Management. New Delhi: Ane Books Pvt Ltd, 2010. Print. Brigham, Eugene & Houston, Joel. Fundamentals of Financial Management. Boston: Cengage Learning, 2011. Print. Coker, Christopher. Globalisation and Insecurity in the Twenty-First Century: NATO and the Management of Risk. London: Routledge, 2014. Print. Doz, Yves & C.K. Prahalad. “How MNCs Cope with Host Government Intervention”. Harvard Business Review 3.5 (2010): 447-468. Print. Eun, Cheol & Resnick, Bruce. International Financial Mgmt. New Delhi: Tata McGraw-Hill Education, 2010. Print. Shapiro, Alan. Multinational Financial Management. New York: John Wiley & Sons, 2009. Print. Wang, Peijie. The Economics of Foreign Exchange and Global Finance. Berlin: Springer Science & Business Media, 2009. Print. Wells, Charlie. “Expats Discover Credit Scores Don’t Travel Well”. Wall Street Journal 5.4 (2015): 225-287. Print. Wursthorn, Michael. “Michael. Morgan Stanley’s Fee-Based Assets Growing”. Wall Street Journal 1.1 (2015): 105-124. Print. Read More