This paper examines the financial considerations that multinational corporations (MNCs) must address when expanding internationally. It covers the range of market entry modes available — including greenfield investment, joint ventures, and mergers and acquisitions — and the distinct financial implications of each. The paper then discusses financing methods such as cash, debt, and equity issuance, and explains how the choice of financing affects a project's net present value. A significant portion addresses foreign currency risk, distinguishing between transactional and translational exposure, and outlines hedging strategies including operating hedges. Finally, the paper considers the impact of differing international accounting standards on overseas operations.
When making the decision to expand internationally, there are a wide range of factors that a multinational corporation must consider. These range from how the expansion fits into the corporation's overall strategy to how products and services will be marketed in foreign nations. There are also a number of financial concerns. The mode of entry is a critical decision that incorporates elements of finance: the expansion must be paid for, so the firm must decide how that will be done. Once the expansion has been undertaken, the firm becomes subject to foreign exchange rate risk, and a strategy must be developed to address that as well. This paper investigates the financial issues surrounding international expansion and outlines some of the ways in which these issues can be resolved.
One of the most important decisions with regard to international expansion is the mode of entry. There are many options, each with its own set of advantages and disadvantages. The company can set up a greenfield subsidiary, establish a joint venture, simply ship product to the country and have local partners handle the marketing aspects, or expand overseas through mergers and acquisitions (M&A). The mode of entry decision will not be based strictly on financial considerations, since each potential mode implies specific strategic objectives, but the financial aspects of each mode are unique and must be considered during the decision-making process.
International expansion can be undertaken strictly with internal resources, or it may involve a joint venture. When partnerships and joint ventures are on the table, it is important for the MNC to determine, in advance of market entry, how the costs of and proceeds from the operation are to be split between itself and its partners. This split will heavily influence both the risk of the project and the cash flows that are expected to result from it.
A merger or acquisition has its own set of financial considerations, including the financing and the impacts that the transaction may have on stock price, capital structure, and the firm's existing shareholders. Each of these factors must be taken into consideration when any international merger or acquisition is being evaluated, because while these impacts may not be strategic in nature, they could have long-run repercussions for the firm's ability to execute its strategy.
All told, the many mode-of-entry options available to MNCs considering international expansion each affect the firm financially in ways that could have far-reaching effects. These effects in turn could have a significant impact on the firm's future profitability, so it is imperative that they are considered during the decision-making process. In general, such effects have been shown to be positive (Doukas & Travlos, 1988), but this also implies elevated risk — which illustrates the need for the financial aspects of international expansions to be addressed with great care.
Once the decision to expand overseas has been made and the mode of entry has been settled upon, the MNC must consider the best method of paying for the transaction. In some cases, the method of payment can have a significant impact on the project's net present value. For example, if a firm wishes to establish a greenfield factory in a foreign country, it could pay with cash, with a debt issue, or with an equity issue. Each of these options carries a different cost of capital and different time frames. As such, the financing decision becomes integral to the project's long-term success.
When a merger or acquisition is undertaken, the decision becomes even more complex. Cash, stock, or debt could all be utilized, but there are further considerations. Acquiring ownership of a foreign company exposes the MNC to a wide range of factors and risks, including political risk, operational risk, and more. Each of these risks carries costs or potential costs that will impact the profitability of the project.
"Transactional vs. translational risk and hedging tools"
"Differing accounting rules across international jurisdictions"
For a multinational corporation, decisions with regard to international expansion are a key part of the business. No decision is made in a vacuum, however, so financial considerations must be included in the decision-making process alongside strategic and marketing-based factors. In particular, decisions with respect to mode of entry are affected by financing and hedging concerns. The finance department must be able to meet local reporting standards and must be prepared to address the new level of foreign exchange rate risk to which the firm will now be subject.
The international expansion will bring in a range of new cash flows, introduce new expenses, and may bring the firm into collaboration through a joint venture with a foreign entity — further increasing the firm's financial risk exposure. A merger or acquisition is a common method of market entry, and that type of activity can have major financial implications, necessitating the input of the finance department at every step of the international expansion decision-making process.
Doukas, J., & Travlos, N. (1988). The effects of corporate multinationalism on shareholder wealth: Evidence from international acquisitions. The Journal of Finance, 43(5), 1161–1175.
No author. (2010). Assessing exchange rate risk. BNet. Retrieved February 11, 2010, from http://www.bnet.com/2410-1323923-68748.html
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