{"id":187,"date":"2015-07-30T01:22:25","date_gmt":"2015-07-30T01:22:25","guid":{"rendered":"https:\/\/courses.candelalearning.com\/intlbusx1xmaster\/?post_type=chapter&p=187"},"modified":"2017-01-09T19:09:40","modified_gmt":"2017-01-09T19:09:40","slug":"financial-management-in-international-business","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/cerritos-internationalbusiness\/chapter\/financial-management-in-international-business\/","title":{"raw":"Reading: Financial Management in International Business","rendered":"Reading: Financial Management in International Business"},"content":{"raw":"
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Learning Objectives<\/h3>\r\n
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  1. Understand the factors that underlie political risk and volatility.<\/li>\r\n\t
  2. Identify two ways in which the financial organization of a multinational firm can be structured.<\/li>\r\n\t
  3. Recognize how religion can influence financial practices in some countries.<\/li>\r\n<\/ol>\r\n<\/div>\r\n
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    Accounting for Political and Economic Risk<\/h2>\r\nCompanies that locate operations in foreign countries face a set of unavoidable risks, chief among which are political and economic risks. Political risks arise from decisions that foreign governments make, including changes in government that result from wars and coups. Economic risks are often paired with political risks but can also arise from international money markets. Both risks are exacerbated by increased volatility and changes in laws.\r\n
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    Increased Volatility<\/h2>\r\nIn the 2010 McKinsey Global Survey<\/em> of 1,416 executives from around the world, 63 percent of respondents \u201cexpect increased overall volatility to become a permanent feature of the global economy.\u201d[footnote]Ren\u00e9e Dye and Elizabeth Stephenson, \u201cFive Forces Reshaping the Global Economy: McKinsey Global Survey Results,\u201d McKinsey Quarterly<\/em>, May 2010, accessed November 23, 2010, http:\/\/www.mckinseyquarterly.com\/Five_forces_reshaping_the_global_economy_McKinsey_Global_Survey_results_2581<\/a>.[\/footnote]<\/span> For example, the most important growing economy in the world, China, is a force that must be reckoned with. The volatility arises because this major economy isn\u2019t a developed state with commitment to the rule of law and strong institutions. Rather, it\u2019s an emerging market where political insecurities are the ultimate driver, according to Ian Bremmer, president of the Eurasia Group and author of The End of the Free Market<\/em>.[footnote]Rik Kirkland, \u201cChina\u2019s State Capitalism and Multinationals: An Interview with the President of Eurasia Group,\u201d McKinsey Quarterly<\/em>, May 2010, accessed November 23, 2010, http:\/\/www.mckinseyquarterly.com\/Chinas_state_capitalism_and_multinationals_An_interview_with_the_president _of_Eurasia_Group_2583<\/a>.[\/footnote]<\/span>\r\n\r\nTo prepare for volatility, multinational companies may want to plan contingencies or at least think through how they might react to events that are currently \u201cunthinkable,\u201d such as significant, rapid shifts in currency values (e.g., a 30 percent decline of the dollar versus an emerging-market currency); an exit from the euro by some nations; dramatic, rapid changes in commodity prices (e.g., oil prices spiking to $200 a barrel); or defaults on debt by major nations.[footnote]Lowell Bryan, \u201cGlobalization\u2019s Critical Imbalances,\u201d McKinsey Quarterly<\/em>, June 2010, accessed October 28, 2010, http:\/\/www.mckinseyquarterly.com\/Globalizations_critical_imbalances_2624<\/a>.[\/footnote]<\/span> These events seem highly improbable now, but, if they come to pass, executives who have thought about how to respond to them will be better positioned to react effectively.\r\n\r\n<\/div>\r\n
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    Legal Infrastructure: Challenges of Nascent Laws<\/h2>\r\nVariations in contract law, bankruptcy law, real estate law, intellectual property rights, and liability are just some of the legal issues that companies face when operating or making investments in emerging-market countries. Slow civil judicial processes, corrupt judges, and potential biases against foreigners can affect a company\u2019s ability to operate effectively, recover losses, or collect bad debts. For example, General Motors (GM) often uses a contractual structure with suppliers in which GM owns the proprietary tooling used in their supplier\u2019s factory. In most countries, if the supplier goes bankrupt, GM can easily take the tooling back. But GM noted that this isn\u2019t possible in China due to the nascent state of the country\u2019s bankruptcy law, which was created only in 1988.[footnote]Harjeet S. Bhabra, Tong Liu, and Dogan Tirtiroglu, \u201cCapital Structure Choice in a Nascent Market,\u201d Financial Management<\/em>, June 22, 2008, accessed November 25, 2010, http:\/\/www.allbusiness.com\/company-activities-management\/company-structures-ownership\/11673477-1.html<\/a>.[\/footnote]<\/span> As a result, GM uses contracts to mitigate these risks.\r\n\r\n<\/div>\r\n<\/div>\r\n
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    Financial Organizational Structure in International Business<\/h2>\r\nMultinational companies can choose to manage their financial operations centrally or via a decentralized organizational structure.\r\n
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    Centralized Structures<\/h2>\r\nThe advantages of a centralized structure<\/span><\/span> are that the company can afford to hire and retain specialized staff with deep expertise who can bring savings to the company through centralized cash management and more efficient capital investment. Centralization can improve control and compliance with corporate policies. This structure enables the firm to gain economies of scale for investment and borrowing activities that can reduce transaction costs and provide the firm with the most competitive pricing.\r\n\r\n<\/div>\r\n
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    Decentralized Structures<\/h2>\r\nAlternatively, multinational firms may choose a decentralized financial organization structure<\/span><\/span> due to variations in language, consumers, cultures, business practices, and government rules, laws, and regulations among different countries. A decentralized structure lets multinational firms exploit local knowledge and business conditions to deal with uncertainty. The downsides of a decentralized approach are higher costs (due to having to hire more employees), some unavoidable duplication of effort, and a diminishment of control.\r\n\r\n<\/div>\r\n
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    Communication with Headquarters<\/h2>\r\nIf a company uses a decentralized financial structure, it\u2019s vital for regional chief financial officers (CFOs) in the different countries to keep regular contact with their superiors at headquarters. Rebecca Norton, vice president of finance, Asia-Pacific, at Business Objects (a unit of SAP), makes it a point to participate in global conference calls as often as possible, in order to \u201cwave the Asia-Pacific flag.\u201d She notes that this is necessary to ensure that her overseas colleagues understand the conditions under which the Asian business operates.[footnote]Don Durfee, \u201cLocal Knowledge,\u201d CFO<\/em>, November 1, 2008, accessed August 12, 2010, http:\/\/www.cfo.com\/printable\/article.cfm\/12465219<\/a>.[\/footnote]<\/span> The reason for the frequent communication is to help the home office better understand the opportunities and risks of the foreign country. For example, if headquarters is focused on short-term performance indicators, the head office is more likely to allocate funds to developed markets where returns are quick. But this approach neglects emerging markets, which have more future potential.\r\n\r\nAccording to a 2010 McKinsey study, global economic activity is shifting from developed to developing nations with populations that are young and growing.[footnote]Ren\u00e9e Dye and Elizabeth Stephenson, \u201cFive Forces Reshaping the Global Economy: McKinsey Global Survey Results,\u201d McKinsey Quarterly<\/em>, May 2010, accessed November 23, 2010, http:\/\/www.mckinseyquarterly.com\/Five_forces_reshaping_the_global_economy_McKinsey_Global_Survey_results_2581<\/a>.[\/footnote]<\/span> The growth in the number of consumers in these emerging markets make them not only a focus for rising consumption and production but also major providers of talent, capital, and innovation. This makes it vital for US companies to succeed in these emerging markets. Despite identifying this trend as the most important trend for business in the next five years, only 40 percent of executives are taking action and fully 20 percent are taking no action at all to capture emerging-market growth.[footnote]Ren\u00e9e Dye and Elizabeth Stephenson, \u201cFive Forces Reshaping the Global Economy: McKinsey Global Survey Results,\u201d McKinsey Quarterly<\/em>, May 2010, accessed November 23, 2010, http:\/\/www.mckinseyquarterly.com\/Five_forces_reshaping_the_global_economy_McKinsey_Global_Survey_results_2581<\/a>.[\/footnote]<\/span> This is where communication with headquarters becomes imperative. Regional CFOs must spur actions, such as developing partnerships or joint ventures with local companies, recruiting talent from emerging markets, and developing new business models.\r\n\r\nOne company taking action is the Luxottica Group, a $6.6 billon eyewear company based in Italy. Although Luxottica sells its products online, it remains solidly committed to brick-and-mortar retail stores and is rapidly expanding its retail presence in China. Describing the role of retail stores, Chris Beer, CEO of Asia Pacific, greater China, and South Africa for Luxoticca, said, \u201cYou need to create a connection, create a personal experience, and that\u2019s what we\u2019ve done.\u201d[footnote]Sheila Shayon, \u201cLuxottica Envisions Future of Retail,\u201d Brand Channel<\/em>, July 22, 2010, accessed November 26, 2010, http:\/\/www.brandchannel.com\/home\/post\/2010\/07\/22\/Luxottica-Eye-Hub-Retail-Concept.aspx<\/a>[\/footnote]<\/span> On the finance side, Kevin Zhou, retail CFO for Luxottica, closely follows the regulatory environment in China and actively communicates with headquarters to explain evolving legislation and help them understand local financial issues. \u201cYou have to always tell them the truth about what\u2019s happening in China, and keep updating them,\u201d he says. \u201cKeep explaining, and before long, people at headquarters will really understand what\u2019s going on in this market.\u201d[footnote]Don Durfee, \u201cLocal Knowledge,\u201d CFO<\/em>, November 1, 2008, accessed August 12, 2010, http:\/\/www.cfo.com\/printable\/article.cfm\/12465219<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n
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    Hybrid Financial Organization Structures<\/h2>\r\nFinally, multinational companies follow a hybrid of centralized financial operations for some tasks and regional operations for others. Before it was acquired by Hewlett-Packard (HP) in April 2010, network switching and routing solutions company 3Com had centralized specific operations in its North America shared service center (SSC). The North America SSC provided a number of accounting services globally. Although the US-based SSC had a much higher cost of labor than Singapore (where 3Com offshored transaction-based processes), 3Com decided to keep higher-value services in the North America SSC due to 3Com\u2019s assessment of the risk and complexity in comparison to the anticipated benefit of moving these from one global center to another. Some of the tasks retained by the North American SSC were worldwide consolidation, worldwide intercompany accounting, and external reporting.\r\n\r\nThe following processes have been performed in each region (i.e., Europe, the Middle East, and Africa [EMEA]; North America; Latin America; and Asia-Pacific) due to language and local knowledge issues:\r\n