Intermediate Corporate Finance – Lecture 1
Chapter 1
The rise of the multinational corporation
Multinational corporation (MNC): company engaged in producing and selling goods or services in
more than one country
• Generally, an MNC consist of a parent company located in the home country and several
foreign subsidiaries, typically with a high degree of strategic interaction among the units
• The rise of MNCs is driven largely by advancements in communications, transportation, and
technology
The rise of MNCs was unanticipated by the classical theory of international trade by Adam
Smith and David Ricardo
• This theory emphasized comparative advantage
= countries should specialize in the production and export of those goods that it can
produce with the highest relative efficiency
• This theory assumes that goods and services can move internationally, but factors of
production, such as capital, labour and land are immobile
• This theory only deals with trade in commodities – undifferentiated products
- Ignores roles of uncertainty, economies of scale, transportation costs, and technology
in international trade
In reality, and becoming more easily, movement of labour, capital is possible
à the ability of corporations of all sizes to use these globally available factors of production is a far
bigger factor in international competitiveness than broad macroeconomic differences among countries
(natural resources)
• Thus, contrary to Smith and Ricardo, the existence of MNCs is based on the international
mobility of certain factors of production
• The traditional world economy in which products are exported is replaced by one in which
value is added to products in several countries
- Value added depends on differences in labour costs and unique national
attributes or skills
o These are again influenced by cultural predilections, historical accidents and
government policies
Example: US has benefited from a culture of innovation, openness and strong infrastructure à
events that boosted US competitiveness include
• Deregulation, collapse of the communist bloc, IT revolution, global use of English for business
• The heightened competitiveness of US firms has compelled European and Japanese rivals to
undergo a similar process of restructuring and renewal
- Specifically, China who has transformed into a major economic force
o China’s low-cost manufacturing has had global ripple effects, from shifting US
jobs to affecting commodity prices
o Recently China has changed focus toward investment in education, science,
and technology, to enter the knowledge economy
Foreign direct investment (FDI): acquisition abroad of companies, property, or physical assets such
as plant and equipment
à MNCs are so the main drivers of global competition
• Globally coordinated allocation of resources by a single centralised management
• MNCs make decisions based on what is best for the corporation as a whole, not just on
individual unit performance
Evolution of the multinational corporation
There has been a rapid growth in foreign investment, which has shown main drivers:
1. Falling trade/investment barriers
2. Cheaper communication and transport
3. Freer domestic and international capital markets
4. Currency hedging and risk reduction
,à not only traditional countries (e.g., US, Japan, GER) but also BRICS (Brazil, Russia, India,
China, and South Africa) have joined the trend
• Fed by rapid economic growth, growing domestic competitive pressures, rise of home-grown
MNCs, high commodity prices, and FDI liberalisation
Reasons of MNC creation
I: Search for raw materials
Raw materials seekers were the earliest corporations and first MNCs
• Aim: exploit raw materials that could be found overseas
• Often secured resources using military force and political manoeuvres
II: Market seeking
Market seeker: MNC that expands overseas to sell products in foreign markets, not just to reduce
costs (ex. Volkswagen, Unilever, MacDonalds)
• Market seeking FDI took off after WWII, mostly from US to Western Europe
• >1980s: reverse FDI
= European and Japanese firms started investing in the US, largely in response to
perceived or actual restriction on exports to these markets
à China joined this trend in the 2000s, heavily investing in Western markets
à foreign markets may be attractive in and of themselves, but MNCs possess certain firm-
specific advantages, like:
• Unique products, processes, technologies, patents, specific rights, specific knowledge and
skills
• MNCs find that the advantages were successful in domestic markets and so can be
profitably used in foreign markets
- In some industries, foreign market entry may be essential for obtaining economies of
scale (costs are otherwise too high to market product)
- There are also companies like Coca-Cola that use their strong brand recognition and
advertising power to dominate international markets
o Keeping out competitors that are wary of the high marketing costs of new-
product introduction
o Entering emerging markets lets MNCs leverage lower costs, reach more
customers, and gain marketing efficiency
III: Cost minimization
A newer type of MNC is the one that seeks low-cost production in countries like India, Malaysia, and
Romania to stay competitive both at home and abroad
à common in electronics and increasingly in services and R&D
Offshoring vs. outsourcing
Offshoring: moving production abroad (internal or external)
Outsourcing: hiring a third-party firm to handle operations (local or foreign)
Production
Internalised (within firm) Externalised (outsourced)
Domestic country Production within the firm locally Outsourced to another local firm
Foreign country (offshoring) Production done in foreign subsidiary Outsourced to a foreign firm
à over time, competitive advantages in product lines or markets can become eroded due to
local and global competition
• Solution: MNCs use their ‘global scanning’ capacity to seek and enter new markets with little
competition or seek out lower production costs sites
- Often involves integrating global production processes to reduce costs
o Plants may specialise in different stages or components of production to
maximize efficiency
IV: Knowledge seeking
Some firms enter foreign markets in order to gain information and experience that is expected to
prove useful elsewhere
, • In industries with rapid product innovation and technical breakthroughs by foreign competitors
it is from great importance to track overseas developments constantly
à best way to do so is by maintaining presence in foreign markets
à the analysis of new foreign products can work as a basis for developing domestic products
that outperform the original
V: Keeping domestic customers
If a supplier only operates domestically and their client expands abroad, the client might switch to a
local foreign supplier to avoid risks like, supply disruptions and trade barriers
• However, if suppliers do not expand internationally, they risk losing both:
- Client’s foreign business
- Possibly their domestic business too if the client switches to a competitor that does
operate globally
VI: Exploiting financial market imperfections
Other reasons for MNCs to engage in FDI:
1. Benefit from financial market imperfections, such as lower taxes or avoiding currency
controls, which can so improve cash flow and reduce funding costs
2. Risk reduction through international diversification
- Spreading operations across countries can stabilize cash flows by reducing reliance
on any one economy
- Despite international investments seem riskier (currency risks, government
intervention), diversification can lower overall risk
- Do notice that diversification may also cause managerial and coordination challenges
The process of overseas expansion by multinationals
Firms usually become multinational companies gradually, starting with exports and later
moving to foreign direct investment (FDI)
• The expansion is often unplanned early on in strategic design, however created later by
competitive pressures (threats) and opportunities
- Firms respond to global competition by trying to gain international advantages and
reduce threats from rivals
The typical sequence of foreign expansion
This step-by-step approach helps to minimize risk and allows the firm to learn and adapt at
each stage before committing further resources
• By internationalizing in phases, a firm can gradually move from a relatively low-risk, low-
return, export-oriented strategy to a higher-risk, higher-return strategy emphasizing the
significant international deployment of assets and production capacity
Options of foreign expansion
1. Exporting: offers a low risk, low start-up costs and quick profits
à often the first step for firms entering uncertain foreign markets
- This phase helps companies learn about foreign markets including supply and
demand, competition, payment systems and distribution
- Successful exporters may then shift from using export agents to direct
relationships with foreign partners
o Eventually firms may establish their own sales subsidiaries, warehouses, and
distribution systems as they gain confidence and reduce uncertainty
- Limits a firm’s ability to fully tap into foreign markets
, 2. Overseas production: allows faster response to local market changes, better after-sale
service, access to skilled labour and R&D globally and stronger local market
commitment and supply reliability
- Foreign production covers a wide spectrum of activities from repairing, packaging,
finishing and processing etc., typically beginning with simpler stages
- Strategic benefits of overseas production:
o Local production can reduce supply risks
o Firms may start with simple tasks and expand to full manufacturing
o Entry strategies evolve over time based on risk-return analysis and market
experience
- How to enter foreign markets:
o Build own operations
§ Sometimes necessary; i.e., in developing countries without local
partners
o Acquire local businesses
§ May create cultural integration issues
§ Use existing marketing networks if available
§ Gain knowledge about local market/particular technology
o Cross-border strategic alliance: partner firms make cross-shareholding
investments in each other and agree on the areas and the extent to
which they want to cooperate
§ Advantages: retain own organisational structure and culture, making
exit easy, share resources
3. Licensing: allows a company to let a local firm manufacture and sell its products in
exchange for royalties or payments
- Advantages: low investment and risk, quick market entry, minimal legal and financial
risks
- Disadvantages: low cash flow, quality control issues, risk of the licensee becoming a
future competitor, hard to control exports from the licensee (especially if local laws
prevent restrictions), after the license expires, the original firm may struggle to re-
enter the market
- Some firms may rely solely on licensing, while others use it alongside joint ventures
or technology-sharing agreements
Choosing between exporting, licensing, and FDI
• Exporting: preferred when intangible assets (like trademarks or patents) can be easily
embedded in products without needing adaptation
• Licensing: works when knowledge can be written down and transferred objectively
• FDI/foreign affiliates: when knowledge is deeply tied to the company’s operations (e.g.,
marketing, quality control, product adaptation)
Key consideration: internalisation (via FDI) is best when market imperfections (like legal or
contractual difficulties) make it hard to manage through external contracts
• Internalisation via FDI: company decides to control operations itself in a foreign country
instead of relying on a partner
• Market imperfections: working with outside partners isn’t reliable or efficient
- Think of: legal/contractual difficulties, transaction costs, hard to protect know-how,
branding, or production methods (secrets)
Types of FDI
1. Vertical integration: investment across stages of production to control supply chain and
avoid risks from external partners
2. Horizontal integration: investment within the same industry to retain control over know-how
and reduce coordination issues with outsiders
Why FDI may be better
Helps avoid misuse of technology, legal restrictions, enforcement challenges
• FDI benefits not only the firm but also the host country, by improving local skills, technology
and productivity
Chapter 1
The rise of the multinational corporation
Multinational corporation (MNC): company engaged in producing and selling goods or services in
more than one country
• Generally, an MNC consist of a parent company located in the home country and several
foreign subsidiaries, typically with a high degree of strategic interaction among the units
• The rise of MNCs is driven largely by advancements in communications, transportation, and
technology
The rise of MNCs was unanticipated by the classical theory of international trade by Adam
Smith and David Ricardo
• This theory emphasized comparative advantage
= countries should specialize in the production and export of those goods that it can
produce with the highest relative efficiency
• This theory assumes that goods and services can move internationally, but factors of
production, such as capital, labour and land are immobile
• This theory only deals with trade in commodities – undifferentiated products
- Ignores roles of uncertainty, economies of scale, transportation costs, and technology
in international trade
In reality, and becoming more easily, movement of labour, capital is possible
à the ability of corporations of all sizes to use these globally available factors of production is a far
bigger factor in international competitiveness than broad macroeconomic differences among countries
(natural resources)
• Thus, contrary to Smith and Ricardo, the existence of MNCs is based on the international
mobility of certain factors of production
• The traditional world economy in which products are exported is replaced by one in which
value is added to products in several countries
- Value added depends on differences in labour costs and unique national
attributes or skills
o These are again influenced by cultural predilections, historical accidents and
government policies
Example: US has benefited from a culture of innovation, openness and strong infrastructure à
events that boosted US competitiveness include
• Deregulation, collapse of the communist bloc, IT revolution, global use of English for business
• The heightened competitiveness of US firms has compelled European and Japanese rivals to
undergo a similar process of restructuring and renewal
- Specifically, China who has transformed into a major economic force
o China’s low-cost manufacturing has had global ripple effects, from shifting US
jobs to affecting commodity prices
o Recently China has changed focus toward investment in education, science,
and technology, to enter the knowledge economy
Foreign direct investment (FDI): acquisition abroad of companies, property, or physical assets such
as plant and equipment
à MNCs are so the main drivers of global competition
• Globally coordinated allocation of resources by a single centralised management
• MNCs make decisions based on what is best for the corporation as a whole, not just on
individual unit performance
Evolution of the multinational corporation
There has been a rapid growth in foreign investment, which has shown main drivers:
1. Falling trade/investment barriers
2. Cheaper communication and transport
3. Freer domestic and international capital markets
4. Currency hedging and risk reduction
,à not only traditional countries (e.g., US, Japan, GER) but also BRICS (Brazil, Russia, India,
China, and South Africa) have joined the trend
• Fed by rapid economic growth, growing domestic competitive pressures, rise of home-grown
MNCs, high commodity prices, and FDI liberalisation
Reasons of MNC creation
I: Search for raw materials
Raw materials seekers were the earliest corporations and first MNCs
• Aim: exploit raw materials that could be found overseas
• Often secured resources using military force and political manoeuvres
II: Market seeking
Market seeker: MNC that expands overseas to sell products in foreign markets, not just to reduce
costs (ex. Volkswagen, Unilever, MacDonalds)
• Market seeking FDI took off after WWII, mostly from US to Western Europe
• >1980s: reverse FDI
= European and Japanese firms started investing in the US, largely in response to
perceived or actual restriction on exports to these markets
à China joined this trend in the 2000s, heavily investing in Western markets
à foreign markets may be attractive in and of themselves, but MNCs possess certain firm-
specific advantages, like:
• Unique products, processes, technologies, patents, specific rights, specific knowledge and
skills
• MNCs find that the advantages were successful in domestic markets and so can be
profitably used in foreign markets
- In some industries, foreign market entry may be essential for obtaining economies of
scale (costs are otherwise too high to market product)
- There are also companies like Coca-Cola that use their strong brand recognition and
advertising power to dominate international markets
o Keeping out competitors that are wary of the high marketing costs of new-
product introduction
o Entering emerging markets lets MNCs leverage lower costs, reach more
customers, and gain marketing efficiency
III: Cost minimization
A newer type of MNC is the one that seeks low-cost production in countries like India, Malaysia, and
Romania to stay competitive both at home and abroad
à common in electronics and increasingly in services and R&D
Offshoring vs. outsourcing
Offshoring: moving production abroad (internal or external)
Outsourcing: hiring a third-party firm to handle operations (local or foreign)
Production
Internalised (within firm) Externalised (outsourced)
Domestic country Production within the firm locally Outsourced to another local firm
Foreign country (offshoring) Production done in foreign subsidiary Outsourced to a foreign firm
à over time, competitive advantages in product lines or markets can become eroded due to
local and global competition
• Solution: MNCs use their ‘global scanning’ capacity to seek and enter new markets with little
competition or seek out lower production costs sites
- Often involves integrating global production processes to reduce costs
o Plants may specialise in different stages or components of production to
maximize efficiency
IV: Knowledge seeking
Some firms enter foreign markets in order to gain information and experience that is expected to
prove useful elsewhere
, • In industries with rapid product innovation and technical breakthroughs by foreign competitors
it is from great importance to track overseas developments constantly
à best way to do so is by maintaining presence in foreign markets
à the analysis of new foreign products can work as a basis for developing domestic products
that outperform the original
V: Keeping domestic customers
If a supplier only operates domestically and their client expands abroad, the client might switch to a
local foreign supplier to avoid risks like, supply disruptions and trade barriers
• However, if suppliers do not expand internationally, they risk losing both:
- Client’s foreign business
- Possibly their domestic business too if the client switches to a competitor that does
operate globally
VI: Exploiting financial market imperfections
Other reasons for MNCs to engage in FDI:
1. Benefit from financial market imperfections, such as lower taxes or avoiding currency
controls, which can so improve cash flow and reduce funding costs
2. Risk reduction through international diversification
- Spreading operations across countries can stabilize cash flows by reducing reliance
on any one economy
- Despite international investments seem riskier (currency risks, government
intervention), diversification can lower overall risk
- Do notice that diversification may also cause managerial and coordination challenges
The process of overseas expansion by multinationals
Firms usually become multinational companies gradually, starting with exports and later
moving to foreign direct investment (FDI)
• The expansion is often unplanned early on in strategic design, however created later by
competitive pressures (threats) and opportunities
- Firms respond to global competition by trying to gain international advantages and
reduce threats from rivals
The typical sequence of foreign expansion
This step-by-step approach helps to minimize risk and allows the firm to learn and adapt at
each stage before committing further resources
• By internationalizing in phases, a firm can gradually move from a relatively low-risk, low-
return, export-oriented strategy to a higher-risk, higher-return strategy emphasizing the
significant international deployment of assets and production capacity
Options of foreign expansion
1. Exporting: offers a low risk, low start-up costs and quick profits
à often the first step for firms entering uncertain foreign markets
- This phase helps companies learn about foreign markets including supply and
demand, competition, payment systems and distribution
- Successful exporters may then shift from using export agents to direct
relationships with foreign partners
o Eventually firms may establish their own sales subsidiaries, warehouses, and
distribution systems as they gain confidence and reduce uncertainty
- Limits a firm’s ability to fully tap into foreign markets
, 2. Overseas production: allows faster response to local market changes, better after-sale
service, access to skilled labour and R&D globally and stronger local market
commitment and supply reliability
- Foreign production covers a wide spectrum of activities from repairing, packaging,
finishing and processing etc., typically beginning with simpler stages
- Strategic benefits of overseas production:
o Local production can reduce supply risks
o Firms may start with simple tasks and expand to full manufacturing
o Entry strategies evolve over time based on risk-return analysis and market
experience
- How to enter foreign markets:
o Build own operations
§ Sometimes necessary; i.e., in developing countries without local
partners
o Acquire local businesses
§ May create cultural integration issues
§ Use existing marketing networks if available
§ Gain knowledge about local market/particular technology
o Cross-border strategic alliance: partner firms make cross-shareholding
investments in each other and agree on the areas and the extent to
which they want to cooperate
§ Advantages: retain own organisational structure and culture, making
exit easy, share resources
3. Licensing: allows a company to let a local firm manufacture and sell its products in
exchange for royalties or payments
- Advantages: low investment and risk, quick market entry, minimal legal and financial
risks
- Disadvantages: low cash flow, quality control issues, risk of the licensee becoming a
future competitor, hard to control exports from the licensee (especially if local laws
prevent restrictions), after the license expires, the original firm may struggle to re-
enter the market
- Some firms may rely solely on licensing, while others use it alongside joint ventures
or technology-sharing agreements
Choosing between exporting, licensing, and FDI
• Exporting: preferred when intangible assets (like trademarks or patents) can be easily
embedded in products without needing adaptation
• Licensing: works when knowledge can be written down and transferred objectively
• FDI/foreign affiliates: when knowledge is deeply tied to the company’s operations (e.g.,
marketing, quality control, product adaptation)
Key consideration: internalisation (via FDI) is best when market imperfections (like legal or
contractual difficulties) make it hard to manage through external contracts
• Internalisation via FDI: company decides to control operations itself in a foreign country
instead of relying on a partner
• Market imperfections: working with outside partners isn’t reliable or efficient
- Think of: legal/contractual difficulties, transaction costs, hard to protect know-how,
branding, or production methods (secrets)
Types of FDI
1. Vertical integration: investment across stages of production to control supply chain and
avoid risks from external partners
2. Horizontal integration: investment within the same industry to retain control over know-how
and reduce coordination issues with outsiders
Why FDI may be better
Helps avoid misuse of technology, legal restrictions, enforcement challenges
• FDI benefits not only the firm but also the host country, by improving local skills, technology
and productivity
