Meeting 1 - Introduction To Multinational Enterprise And Multinational Financial Management

International Finance Seminar 3 March 2007

“ Growing Together … A Place to Learn and Grow “ 1 Silitonga Tony

Opening Profile: The Daimler-Chrysler AG Global Alliance •The $92 billion merger of Daimler-Benz and Chrysler to form Daimler-Chrysler Akteingesellschaft represents a triumph of the global economy and the end of car companies as national emblems of industrial might. •The two CEOs announced that they expect immediate growth opportunities by using each other’s facilities, capacities, and infrastructure. •DaimlerChrysler expects to realize benefits of DM 2.5bn ($1.4bn) through the exchange of components and technologies, combined purchasing power, and shared distribution logistics, and they expect further synergies to accrue by sharing know-how in engineering and manufacturing. •These are 2 giant industrial companies with a Tony total 2 Silitonga

Brief Facilitator’s Resume Tony Silitonga has been working for more than twenty (20) years in different countries, different industries, with different multinationals, such as: IBM, Atlantic Richfield Oil & Gas Company (Indonesia), Standard Chartered Bank (Philippines), Merrill Lynch (USA), and China Development Corporation (Taiwan). He is a member founder of Indonesian Finance Association (IFA), FORESPECT and Optima Quadra. Graduated from Bandung Institute of Technology major in Petroleum Engineering, he has got his Master in Business Management (MBM) majoring in Finance and Strategic Management from Asian Institute of Management (AIM), Makati (Philippines), and MBA from Columbia Business School (CBS), New York (USA) Finance-Exchange scholars’ program. Recently, he is finalizing his Dissertation for Doctorate in Business Administration (DBA) from De LaSalle University – Manila (Philippines), major in Finance, Strategic Management, and Good Corporate governance. He is now Executive Director of Indonesian Institute for Corporate Directorship (IICD), an institution that was founded in the year 2000 by 10 leading Indonesian Universities, members of IDEANET (International Directors East Asia Network), and was financed by leading International Institutions, such as: The World Bank, and Asian Development Bank. IICD has a vision of Internalizing Best Practices of Good Corporate Governance and Directorship. 3 Silitonga Tony

Selected Hands-on Advisories:

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Selected Hands-on Consultancies: STANDARD CHARTERED BANK, The Philippines MERRILL LYNCH, New York, USA STERLING TRANSTRADE, Manila, The Philippines DRUGSTORE, INC., Manila, The Philippines ELNUSA HOLDING CO., Jakarta, Indonesia GLOBAL FOREST, INC., Singapore VISEAN ONLINE PTY LTD, Richmond, VIC, Australia GRANSTAR MOTOR, Manila, The Philippines PT.INHUTANI III, Jakarta, Indonesia

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International Finance 1 Meeting st

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Multinational Enterprise and Multinational Financial Management 10 Tony Silitonga

Topics I.

The Rise of the Multinational Corporation II. The Internationalization of Business and Finance III. Multinational Financial Management: Theory and Practice

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION

I. The MNC: Definition a company with production and distribution facilities in more than one country.

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION A. Forces Changing Global Markets Massive deregulation Collapse of communism Privatizations of state-owned industries Revolution in information technology Wave of M&A Emergence of free market policies Rise of Big Emerging Markets (BEMs)

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION B. Prime Transmitter of Competitive Forces in the Global Economy: The MNC emphases group performance such as Global coordinated allocation of resources Market – entry strategy Ownership of foreign operations Production, marketing and financial activities

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION

C. EVOLUTION OF THE MNC Reasons to Go Global: 1. More raw materials 2. New markets 3. Minimize costs of production

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION RAW MATERIAL SEEKERS exploit markets in other countries historically first to appear modern-day counterparts British Petroleum Exxon

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION MARKET SEEKERS produce and sell in foreign markets heavy foreign direct investors representative firms: IBM MacDonald’s Nestle Levi Strauss

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION COST MINIMIZERS seek lower-cost production abroad motive: to remain cost competitive Texas Instruments Intel Seagate Technology

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PART I. THE RISE OF THE MULTINATIONAL CORPORATION D. THE MNC: A BEHAVIORAL VIEW State of mind: committed to producing, undertaking investment and marketing, and financing globally. 19 Silitonga Tony

PART I. THE RISE OF THE MULTINATIONAL CORPORATION E. THE GLOBAL MANAGER 1. Understands political and economic differences; 2. Searches for most costeffective suppliers; 3. Evaluates changes on value of the firm.

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Part II. The Internationalization of Business and Finance Globalization A. Political and Labor Union Concerns

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Part II. The Internationalization of Business and Finance B. Consequences of Global Competition Acceleration of the global economy

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE I. THE MULTINATIONAL FINANCIAL SYSTEM A. Main Objective of MNC: Maximize shareholder wealth B. Other Objectives Reflect Ability to Link: via affiliate transfer mechanisms

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE C. Mode of Transfer: Reflects freedom to select a variety of financial channels. D. Timing Flexibility: Most MNC have some flexibility in timing of fund flows.

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE E. Value The ability to avoid national taxes has led to controversy.

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE

II. FUNCTIONS OF FINANCIAL MANAGEMENT A. Two Basic Functions: 1. Financing 2. Investing

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE

B. Additional Factors Facing the MNC Executive 1. Political risk 2. Economic risk

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE

III. THEORETICAL FOUNDATIONS A. Useful Concepts from Financial Economics: 1. Arbitrage 2. Market Efficiency 3. Capital Asset Pricing

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PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE

B. Importance of Total Risk 1. Adverse Impact lower sales and higher costs 2. Justifies hedging activities of MNC 3. Diversification reduces risk 29 Silitonga Tony

PART III. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE

IV. THE GLOBAL FINANCIAL MARKET PLACE A. Inter-linkage by Computers B. Market Acts as A Global Referendum Process: Currencies may rise or fall 30 Silitonga Tony

1. “Globalization and Its Critics: A Survey of Globalization” by the Economist: on profit, on the poor, on government, on legitimacy, on finance, on WTO, and on manifesto. 2. Amartya Sen, "How to Judge Globalism," The American Prospect vol. 13 no. 1, January 1, 2002 - January 14, 2002

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History of International Financial System

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There are three historically important periods in the evolution of the system: A. Pre-1944 Era (Gold Standard Era): exchange rates were based on gold; B. 1944-1973 Era (Bretton Woods): exchange rates were pegged; C. Post-1973 Era: exchange rates are market determined.

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A. Pre-1944 Era (Gold Standard Era): exchange rates were based on gold; Currency is valued against Gold & mint parity is established between two currencies Stage 1- Gold specie standard-currency in circulation was gold coins Stage 2- Gold Bullion Standard-currency in circulation is paper currency convertible in fixed amount of gold Stage 3-Gold exchange standard eg:-1$=0.00125 ounce gold 1pound = 0.005ounce gold

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A. Pre-1944 Era (Gold Standard Era): exchange rates were based on gold; Fixed Exchange Rate System: “Rule of Game” Each currency was set in value per ounce of gold: $20.67/oz.; 4.25 British pound / oz. ==> Ex = $20.67/ 4.25 1 British pound = $4.86 (=par value) Based on PPP or cross-rate: Most traders quote currency values against the US$ if the exchange for a currency is stated without using US$ as a reference, it is known as a cross rate.

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A. Pre-1944 Era (Gold Standard Era): exchange rates were based on gold; Government stood ready to buy or sell gold at parity value and gold is allowed to move in and out of country add faith (credit) to currency.

Impacts ??? A. Imposed monetary discipline on participating countries. A country could not expand its money supply at a rate faster than gold accumulation inherently anti-inflationary. B. Free-flow of gold may correct trade imbalance Gold flows out of trade-deficit country and reduces its money supply (Remember gold is money.) The economic and business activities slow down (due to higher interest rates). 36 Silitonga Tony Residents consume less Reduce

B. 1944-1973 Era (Bretton Woods): exchange rates were pegged; 1. Fixed Exchange Rate: “Adjustable peg”; +/- 1% of par value; all currencies pegged to gold. 2. Only governments can convert US $ into gold: $35/oz.gold. 3. Trade imbalance Deficits: selling foreign currency and buying home currency to prevent it from devaluation below par value. Surplus: buying foreign currency and selling home currency to prevent it from appreciating above par value. 4. IMF, World Bank, SDR to improve economic cooperation and liquidity.

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B. 1944-1973 Era (Bretton Woods): exchange rates were pegged; Collapse in 1971 because: (1) budget deficit and high inflation in US -- financing Vietnam War. (2) oversupply of US dollar and inadequate amount of gold to be converted.

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C. Post-1973 Era: exchange rates are market determined. The exchange rate is determined by supply and demand which are affected by inflation rates, interest rates, growth, expectation, etc. may have high volatility.

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Alternatives Exchange Rates System Least A. Free Float B. Managed Float C. Target Zone D. Fixed Rate E. Hybrid (Any Combination of A, B, and C)

Degree of government control Most

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Alternatives Exchange Rates System Managed Float Reducing uncertainty of exchange rate movement by controlling bank intervention (buy or sell foreign currency). (1) Smooth out daily fluctuations, eliminate “excessive” volatility. (2) Lean against the wind; delay exchange rate adjustment. (3) Unofficial pegging.

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Alternatives Exchange Rates System Target-zone arrangement linking currencies in a target-zone and adjusting economic policy to keep exchange rate in a range/zone. European Monetary System

European currency unit coordination of econ. policy: fiscal deficits, growth, money supply, etc. Intervention will not work if the monetary policy is inappropriate. Exchange rate cannot be stabilized.

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Alternatives Exchange Rates System Fixed Rate These countries depend on international trade with each other for survival. Fixed rate aids trade. The success of such a system relies heavily on the willingness of individual govt. to sacrifice internal econ. policy goals for the maintenance of external policy goals (i.e. fixed rate). It requires a single banking system and single monetary policy so that capital can flow freely between countries and yet maintain a fixed rate system. Higher interest rates will attract massive capital flows which threaten the fixed rate system. In order to maintain the fixed rate system, interest rate differences must be eliminated by having one solid monetary policy (and therefore one interest rate) for all of the community.

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Monetary System Domestic Monetary System (DMS) International Function of DMS Monetary System (IMS) 1. Provision of adequate liquidity 2. Operation of smooth adjustment mechanism is process in the economy that work to assure a nation external economic equilibrium, well balanced international payment system 3. Confidence in the system: Govt. policies must be such that they gain confidence of private sector business firms and investors

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Monetary System Domestic Monetary System (DMS) International Monetary System (IMS) Components of IMS 1. IMF 2. Foreign Exchange market 3. Official Reserves 4. Private Demand for Foreign Exchange 5. Intervention & swap network

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International Monetary System (IMS) Evolution Gold Exhange Standard after world war1, countries found it difficult to stick to gold standard because of increased differential inflation. world trade declined thoroughly and faced great depression in 1930’s..Then came the world war 2...after its conclusion in 1944,

Bretton woods conference took place & the new system of exchange rates .In the 60’s inflation had risen very high & private parties outside US to accumulate the dolar. Also the US trade deficit increased. It was clear that dolar had been overvalued & might have to be devalued to restore the equilibrium in he US trade balance. So every one wanted to change $ into hard European currency. Thus the US$ was devalued against most of the currencies & gold convertibility of $ was suspended. A new agreement “the smith sonian agreement “ was entered into. US$ was devalued & a wider range of currency fluctuation was permitted (2.25% instead of 1%)

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International Monetary System (IMS) Evolution (Post War) 1. Shortage (1946-52) – World demand for $ exceeded supply. American goods were in demand. 2. Stability (1953-57) – By 1952, Western Europe had regained prewar levels of industrial production facilitated by generous provisions of $ credits and aids under “European recovery” program of 1947-52 (known as marshal plan healthy and stable economic environment). Forex markets in Europe were liberalized. 3. Emerging payments problem (1958-63) - Formation of common market, common external tariff was introducedresulted in American corporations faced problems. They had to invest within the group. Sharp increase in the capital outflow from US to Europe showed adversely on BOP of US. 4. Capital controls (1964-70) – In 1963 Kennedy government imposed interest equalization tax (IET). 15% tax was charged to US investors for buying foreign stock. This made funds costlier for foreign borrowers. This did not solve the problem, So further capital controls were introduced. 5. International financial crisis (1971-73) – Bretton woods system was based 47 Silitonga Tony upon strong and stable US $.

International Monetary System (IMS) Evolution (Post War) 6. Petrodollar (1974-81) -OPEC-organisation of oil exporting countries gave two Oil shocks & surplus is called Petrodollar 7. International debt crisis (1982-83)- Mexico - due to widest debt service problems facing the developing nation (Debt service is the total debt at the end of the year in % of exports of goods and services in year indicated).

8. Forex market Evolution(1985) Plaza accord – In 1981-84 US$ appreciated and imported goods become more attractive to Americans. This increase trade deficit was introduced. Two new supra-national institutions were born

“The IMF” and “The World Bank”.

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International Monetary System (IMS) Evolution (Post War) 9. Emergence of Japan as leading international financial power & source of global capital I 1980’s

10.In 1987 seven countries (G-7) reached accord in Paris to support the falling US $ by pegging exchange rates within a narrow range 11.During 1989-92 many changed in political system from communist to multiparty govt. converting planned economies to free economies. 12. Unification of European market after NAFTA(north free trade agreement) between USA, Mexico and Canada 1993 & APEC(Asia Pacific Economic Corporation) has intensified regional development. Increasing importance of emerging capital market as a part of global finance in the 1990s 13. South East Asian Currency Crisis of 1997-1998

14. Euro as a common currency in 1998 Eurobank,Eurocurrency,Eurograms,European currency-Euro?

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International Monetary System IMS) Application ??? A. England German re-unification  large expenses and high inflation  tightened monetary policy to slow inflation rate  Result: interest rates rose significantly  capital flow from UK and Italy to earn high interest rates  UK could not afford to increase interest rates high enough to keep capital at home.

UK withdrew from the EMR (Exchange rate mechanism) 50 Silitonga Tony

International Monetary System IMS) Application ??? B. Mexico - Peso devalued in 1976 and 1982. Why? (1) Govt. overpromised: providing social service, education, medical care, etc. to buy vote. How to finance their subsidiary: increases taxes or borrow? (print Peso  increase inflation)  devaluation in 1976. (2) Discovered oil in the late 1970s and Mexico became rich. ==> spent and borrowed more (mortgaged oil). not enough  print Peso  Devaluation in 1982.

Summary: When oil price increased, Mexican govt. raised their living standard. When oil price decreased, Mexican govt. did not cut spending but borrowed more.  maintained fixed Peso/dollar exchange rate which increased real value of Peso.  Before 1982, real value of Peso was high and had balance of 51 Silitonga Tony payments deficits.

International Monetary System IMS) Application ??? What about …

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Jeffrey Sachs, Aaron Tornell, Andres Velesco, “The Collapse of the Mexican Peso: What Have We Learned?”

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