The Multinational Finance Function

Conclusion

This paper explores the theme of the multinational finance function of the firm that seeks to grow its operations in foreign markets. To provide a theoretical overview for the theme, various facets of the finance function of a firm were explored.
This included beginning the analysis with the CFO and the crucial role they play in the decision making process of the financial management team of the firm. They are required to make three key decisions to achieve a firm’s overall goal of maximizing profit for the shareholders. This includes the investment decision; the finance decision and the managing the short term cash needs. The CFO needs to manage all these functions on a global level.
A key component of this analysis is understanding how a firm generates revenue from capital b ...

Content



Content 2
Introduction 3
Theoretical overview 5
Function of the CFO 5
Global Capital Budgeting Methods and Issues 7
Accessing the International Capital Market and Capital Structure 10
Capital structure - Financing and potential fund sourcing 12
Global stock market sizing 13
Offshore financing strategies 14
Managing Risk Globally 16
Creating a Global Finance Function 17
Case application of Raiffeisen Bank in Eastern Europe 21
Conclusion 28
References 31

Introduction

Thispaper exploresthe financial operations and risks during company's expansion into the world market, how to successfully manage them and further minimize any risks that may arise. As we become more interconnected globally, the need for firm’s to expand their operations to foreign markets becomes increasing important to remain profitable and competitive.
The structure of paper will follow a theoretical overview that will explore the crucial role of the CFO in the multinational finance function of a firm. Then a theoretical overview of various capital budgeting methods will be explored as well as various issues that may arise.
Following on from this the important financial instruments of debt and equity will be explained in relation to the international finance function and how these instruments can be leverage by firms to ensure profitability in a global setting.
As a firm expands globally, accessing the international capital markets becomes an important factor to its success. Especially in regards to means in which it will sourceits funds and financing it’s projects. Additionally firms need to evaluate the size of global stock market sizing and the region in which it seeks to operate as this can have a bearing on its success.
Offshore Financing is an important and topic issue for firms. Especially as this method of financing is not only profitable but also helps to mitigate risks. CFO’s need to be aware of the benefits and risks associated with offshore financing; especially in light of recent events bring the issue to global attention.
Crucially, as firms expand their operations they can be exposed to greater risk. Risks can come in numerous forms and it is important for firms to implement strong risk management strategies to remain competitive.
The aforementioned theoretical analysis will be applied in a contemporary contemporary setting, focusing mainly from a European perspective in light of the recent economic developments in Russia. This case analysis will highlight the difficulties the finance function of a firm faces as it tries to remain profitable in a global setting
Furthermore some strategic insights and recommendations will be determined from both a theoretical perspective and from a contemporary standpoint in light of how the finance function a firm can ensure a global firm remains competitive.

5). For many companies, one of the most important steps is when they first reach out to seek external equity capital funding from a wide and anonymous circle of investors. This is ‘typically done through an initial public offering when the company’s shares are also listed for public trading on a stock exchange’ (OECD pg. 10). Through IPOs, companies are forced to adhere to more rigorous and standardised firm requirements like reporting their financials, shareholder rights and disclosing firm information.Raising equity has a unique advantage however. Initially, the raising of equity capital is eternal in the sense that once it has been ‘provided it cannot be withdrawn by the individual capital provider - the shareholder’ (OECD article pg. 7). This is different from debt instruments, such as bank loans, where the firm in debt must repay the debt upon its maturity date. However, for equity stakeholders to gain access to their returns all stakeholders must be paid first. This means that if the investment doesn’t become profitable, the investor bares that risk. Thus equity capital attaches a higher risk premium. For firms operating in foreign markets, this risk premium may be much higher for various reasons such as economic climate or political instability. This is usually not the case for most western firms operating in western markets where one can take the assumption of the capital market being integrated.However, in some developing countries this may not be the case. Where investors do not have equal rights to securities, the capital market is said to be segmented (Berk pg. 700). An example of this is where a firm may have a strong reputation one country, but not in another. The implication of this is that a firm may have easier access to debt and equity capital in the country of prominence, but in a market where they not well know the firm might have a harder time gaining access to capital, as investors require a higher rate of return due to the perceived risk. This is called differential access (Berk pg. 700). Firms can overcome these using strategies such as raising extra capital in their local market or currency swaps to gain better access to the market.A further issue for accessing the capital market is macro-economic factors. These factors can create barriers to access foreign cash flows thus segmenting the market. Issues such political instability, cultural norms, regulation of the market or corruption can all increase the risk premium required by investors. However, firms can exploit this through investing in high-risk foreign markets and raising capital in the low risk countries. This can assist in creating leverage for firms as they compete on the global market (Berk pg. 702). Countries and also use this to their advantage by making their country attractive to invest in for firms seeking to create profitable projects.This has been clearly demonstrated by recent trends where the number of IPOs in emerging markets has far outpaced that of their western counterparts (OECD article pg. 10). In 2000, there were over 700 IPOs in Europe alone. In 2014 this figure has dropped to under 300. Furthermore, Nearly 60% of emerging market firms are now issuing corporate bonds (OECD article pg. 13). As we already know, corporate bonds are an important source of financing for global firms seeking lower risk investments. This allows greater financial flexibility in the global economy, especially for firms seeking to go global but still create a safety net for their investors.Capital structure - Financing and potential fund sourcingA CFO can also take advantage of institutional differences across a company’s operations allow plenty of scope for creating value through wise financing decisions. Because interest is typically deductible, a CFO can significantly reduce a group’s overall tax bill by ‘borrowing disproportionately in countries with high tax rates and lending the excess cash to operations in countries with lower rates’ (Desai, Harvard Business Review). Therefore, CFOs can take advantage of this variation in the capital structure by ‘carefully timing and sizing the flows of profits from subsidiaries to the parent’ (Desai, Harvard Business Review). This is a crucial advantage for firm that seeks to operate globally as they can take advantage of different countries lending facilities and rates in order to finance its various operations.Taking advantage of a multinational firms capital structure also has further benefits. They can also exploit their internal capital markets in ‘order to gain a competitive advantage in countries when financing for local firms becomes very expensive’ (Desai, Harvard Business Review). For example, during the Asian financial crisis of the 1990’s, firms were having great difficulty raising money and accessing the capital market due to the financial situation. Therefore, western firms were able to borrow money through the subsidiaries at home to finance their projects in Asia. This game them great leverage and helped generate a strong market share in these markets. This is a great example of how utilizing the capital structure of a firm to enable greater success operating in the global market.However, CFO’s do need to be aware of the potential negative effects of financing in this fashion. But raising debt with their subsidiaries, there is potential to hinder their reputations and profit potential, therefore eating away at their profit margins. CFO’s need to be aware of this and ensure that subsidiaries remain healthy, especially at home to ensure overall financial health of the firm globally.Global stock market sizingHaving an idea of the global stock market sizing can be an important factor as Firm’s seek to go global. Whilst, there are factors to numerous to list here as to why a Firm would choose a market to operate in, there are a few general sizing issues to be aware of. Global financial assets hit the 3 trillion mark in 2015, with nearly one quarter of that amount in stocks (McKinsey and Company, see reference sheet). This is nearly double the 2008 estimate. However, over 90% of global stock value is divided between North America, Europe and East Asian stock exchanges. This puts the foothold of wealth squarely on the developed world’s traditional markets of the United States, Western Europe and Japan (see attached article 3). The US stock exchange alone accounts for nearly half of all global stocks. What does mean for firms looking to globalize. Well a few things. Firstly, the traditional markets are still the safe and most profitable markets to invest in. They have the most stable currencies and highest concentrations of wealth and as an investors looking for security and low risk premiums, western markets still hold the key. As for emerging markets, firms face a combination of political instability, infrastructure issues, smaller market capitalization and currency fluctuations. As mentioned prior this creates a much higher risk premium for investors. However, there is great potential for firms entering emerging markets to take advantage of first mover initiatives and create a strong market share. In emerging markets such as Africa and India, there is huge profit potential with lower costs, huge populations and looser regulatory control. If firms can leverage the benefits while mitigating the risks there is great profit potential in investing in emerging markets.Offshore financing strategiesWith the recent release of the Panama papers, offshore financing has become a controversial contemporary issue. What most people don’t realize is that offshore financing is a useful and powerful tool that companies can leverage to improve business. A great example is firms using offshore financing to pool all their funds in a single currency bank account, thus reducing fees and creating more certainty in their operations. CFO’s can have a clearer idea on the situation of the firm’s financial health as well as mitigating risks as the firm grows on a global level. Offshore financing is an ‘essential cog in a world of increasingly cross-border trade and investment’ (Financial Times article).Offshore financing allows firms to mitigate numerous issues that arise in cross border investments. An example of this is mitigating jurisdictional issues in different countries where a firm operates. Each country has its own set of laws and tax regulations when it comes to dealing with corporations. It takes a huge amount of work at great cost to ensure that the firm is compliant with regulations, thus avoiding heavy penalties. Offshore financing allows firms to create stability by concentrating the resources in a single entity. This allows huge corporations such as Apple and Google to control their costs and provide better clarity on their financial health for investors.The Boston Consulting Group recently revealed in a Financial Times article that private wealth in offshore finance centers grew by 7 per cent in 2014 to reach 11 trillion dollars (Financial Times, April 2016). The consulting firm explained that the ‘Current political and economic tensions, such as those in the Middle East and Latin America, continue to drive the demand for offshore domiciles that offer high levels of stability’ (Financial Times, April 2016). Furthermore, offshore financing in countries with no or little tax is looked favorably upon by investors to avoid double taxation in their home countries. An important reason for offshore processing that is allows investment flows in and out of foreign marks to benefit from more efficient systems and abilities to incorporate than in the market itself. This is quite prevalent with firms operating in China, as the government there is oppressive and stringent policies towards corporations. As a quoted in a financial times article, a leading western financial scholar explains that the ‘ease of incorporation, the ability to reduce capital and issue different classes of shares, the reliance on tried and tested legal concepts and systems, the flexibility of corporate structures and the tax-neutral treatment of investment from different sources all argue in favor of using international financial centers to invest in foreign markets’ (Financial Times, April 2016).However, with the recent Panama papers leak, there is a growing demand globally for more transparency in the offshore financing process. As a recent article in The Economist explains that offshore processing centers are often viewed as ‘Treasure Islands’ that serve as secretive projects of the ‘elites against their, and our, societies’ (The Economist, April 2016). The negative view of corporations as money launders acting against the interests of a global society, is a pervasive one that is now firmly entrenched in the mindset of the global citizen due to the Panama Papers. Calls for more transparency can work in the favor of corporations that embrace clarity. For one, it will create new international standards for financial reporting.Managing Risk GloballyAs a firm seeks to expand and grow there are many potential benefits. However, as KPMG article explains, there are increased risks for firms going ranging from operational issues, the availability of capital, financial and geopolitical risks. These all have to be managed strategically to ensure the firm remains profitable (KPMG report 2010). This scope of this paper will focus on mitigating the financial risk as a firm goes global. As mentioned earlier, firms can use currency swaps and forward contracts to fix any currency issues to mitigate swings in unstable markets. But what else can firms do to minimize their financial risk.A Harvard Business Review article explains that using a firm’s internal capital market can also assist the firm’s risk-management options by broadening and diversifying that risk (Desai, Harvard Business Review). For example, instead of simply managing all currency exposures the firm faces through the financial market, global firms can mitigate natural currency exposures through their internal, global operations. Even though there is great potential in this strategy of mitigating risk, many firms still let their subsidiaries manage their own local risk. An example of this the case of General Motors where even though they have a strong financial department, GM’s hedging policy requires ‘each geographic region to hedge its exposures independently, thereby vitiating the benefits of a strong, centralized treasury’ (Desai, Harvard Business Review). What is the reason for the firm to take this view? The core strategy for this reason is that general motors want greater clarity into the financial health of each subsidiary. Therefore by allowing them to manage their own risks locally, management can gauge the viability of the business. IT must be noted though that general motors still uses other means to safeguard its assets and cash flows. Creating a Global Finance FunctionHow can CFOs ensure that their global finance operations in their control allow for the greatest profit for the firm? At a basic level, financial managers must ensure that their operations and financial capabilities are aligned with the goals of the firm. To ensure that financial managers succeed in doing this, they must ensure that there aspects are met.The first aspect is establishing the relevant decision making focus that region that the firm operates in. Using the example of general motors gain of hedging dictates that the global finance function must delegate decision making for a certain geographical market to that level even if it is at an extra cost. Even if centralizing decisions can ‘generate substantial savings, these might need to be sacrificed to ensure that the finance function reflects the degree of centralization appropriate for the firm overall’ (Desai, Harvard Business Review). However, some highly centralized firms can utilize a large central global finance function that delegates the fanatical policy and decisions making requirement to its subsidiaries. This allows firms to have their organizational and financial goals left intact, while still adapting its localized businesses to the market it is operating in. This is crucial as it allows large corporations to be more nimble strategically and adapt to changes in the local market, but still retaining their core strategic vision. In a risk mitigation sense, the helps to firm manage the risks that are apparent in that particular market while ensuring clarity to the centralized management as to the financial vitality of the investment.The second aspect that the global finance function can employ is to create and team of financial managers and trained to professions to rotate globally through its various operations. An article in the Harvard Business Review explains, ‘leading companies recruit and rotate financial managers in the same way that they do marketing and operational talent’, as this allows them to ‘groom a network of finance professionals who are comfortable in various environments and have rotated through positions at the country, region, and corporate levels’ (Desai, Harvard Business Review). What this enables a firm to achieve is a dynamic corporate environment where its financial team has the expertise and knows how to make better financial decisions due to the increased exposure and experiences they receive. The dynamic that is created between the financial headquarters, where the majority of the firm’s knowledge is concentrated, and the subsidiary can be a powerful resource in difficult times (Desai, Harvard Business Review). This is especially true when local market knowledge is required to solve the issue at hand. An example of this occurring was in the case of the drug giant Novartis. In 2001, the company had to decide whether to continue financing its Turkish subsidiary, which was undergoing some issues of financial hardship. Due to the weak financials the company had to decide whether to get the managers to acquire local funding or whether to stop shipping to the subsidiary. After numerous tense negations, it was decided to keep operating the subsidiary and to capitalize on the weakness of its competitors, and eventually reimburse the parent company. A successful outcome was achieved only ‘because of the trust built up over many years between finance managers at headquarters and those in Turkey, many of who had spent time at Novartis subsidiaries around the world’ (Desai, Harvard Business Review). They key here for firms is create a strong and valuable relationship between the centralized finance function and the local subsidiaries with local in depth knowledge. This allows firms to gain unique insights into the local market and leverage these for gain. This is an important aspect for firms looking to enter the global market to ensure they are not exposed to risks in foreign markets. The third aspect is creating codes of conduct and practices that can then be delegated to subsidiaries and adapted to the local market. Smart firms realize that to succeed in the global market, they need to understand that local strategies and implementation need to be flexible to account for local idiosyncrasies. Firms often want to create universal norms across the board to ensure clarity and uniformity, regardless of local norms and idiosyncrasies in local market. However, such a tactic can leave a firm exposed or miss crucial opportunities in the local market due to rigid policies. Similarly, strategic objectives, as in the Asahi example, may demand flexibility in investment analyses. Specifying the process for making exceptions, such as instituting a standing committee of finance professionals to review possibilities, is critical to ensuring that deviations from the norm are properly managed. Case application of Raiffeisen Bank in Eastern EuropeRaiffeissen are a European banking conglomerate that base their business model on a cooperative focused specifically on both the wealthy and the poor. The bank began in the 1800s in Germany where the rich in the community would make their excess money available at a reasonable rate so that the bank could then lend money to the poor so that they could get by. This is how cooperatives sprung up in many different places across Germany, each operating within their own area. As the Raiffeissen cooperative grew, it did not become a conglomerate. Instead, the idea spread, creating new, small cooperatives everywhere that were positioned in the heart of the community. However, eventually a parent organization was created as all the small cooperatives in all of the various towns across Germany became vulnerable and exposed to risk of running into difficulties. To solve this issue Raiffeisen created a central cooperative, of which all the different credit cooperatives were members, and the cooperatives could therefore jump in and help each other when required.Out this grew the modern Raiffeisen Bank centered in Austria. It still retained its cooperative base, but took a more modern approach of business banking model focused on profit and growth. The Raiffessen model is a hybrid of ‘glocalization’ cooperative model and the modern profit driven firm. Raiffeisen focuses both on local ties and international strength.