The international financial environment differs from the domestic financial environment because of influences from various elements, including corporate governance, the international monetary system, and the balance of payments. Corporate governance refers to management’s objective and mission to optimize shareholders’ value and return on their investment within an organization over time (Eiteman et al, 2010). An organization’s corporate governance is influenced by internal forces and external forces. Internal forces are corporate officers such as chief executive officers and the board of directors and external factors such as the equity markets, debts markets, auditors, legal advisors, are influenced by foreign countries’ regulations and institutional practices (Eiteman et al, 2010). The international monetary system refers to exchange rates regimes and types of monetary systems utilized among foreign countries. Exchange rate regimes are classified under one of eight categories, which vary from exchange arrangements with no separate legal tender to independent floating regimes. However, the most frequently-used are independent floating regimes that are used by firms in developed countries such as Japan, the United States, and the United Kingdom (Eiteman et al, 2010). The balance of payments (BOP) measures economic transactions that occur between a country’s residents and foreign residents (Eiteman et al, 2010). An understanding of the BOP is essential to operating in the global environment because it provides an indication about foreign exchange rates; changes in a country’s BOP; and forecasts countries’ market potential (Eiteman et al, 2010).
Foreign Exchange Market
The foundation of the foreign exchange market is the purchasing power parity because it explains the relationship among prices, exchange rates, and interest (Eiteman et al, 2010). These relationships are explained by the Fisher effect and international Fisher effect. The Fisher effect defines the relationship between a country’s nominal interest rate, real rate of interest, and inflation; and the international Fisher effect defines the percentage change in spot exchange rates and differential comparable interest rates (Eiteman et al, 2010). Knowledge of the Fisher effect and international Fisher effect are required for multinational enterprises because they assist management with using effective methods to forecast foreign exchange rates. Firms use three approaches for determining and forecasting foreign exchange rates: the monetary, asset market, and technical analysis approach. The monetary approach assumes that rates are influenced by supply and demand for national monetary stocks; the asset market approach assumes that rates are based on supply and demand, but for a wide range of financial assets (Eiteman et al, 2010). The technical analysis approach, which is the most reliable, assumes that rates are driven by market prices and bases forecasts on price movements (Eiteman et al, 2010).
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After forecasting foreign exchange rates, firms must implement strategies to reduce the impact of rate fluctuations on their revenues, expenses, and profitability for budgeting and planning purpose. Hedging, the process of acquiring cash flow, assets, or contracts that move with foreign currency, is the most common strategy used to manage the impact of unexpected changes (Eiteman et al, 2010). Firms may choose from multiple forms of hedging, including contractual, operating, and financial. Contractual hedging involves the use of methods such forwards, futures, and options; operational and financial hedging are similar because they use risk-sharing agreements to offset operating cash flows, offset debt obligations, or financial derivatives (Eiteman et al, 2010).
Global Cost of Capital
Because firms operating in the global environment operate in multiple markets, they need to utilize strategies that will allow them to compete in both global and domestic markets, which is possible when they use the global markets to maximize access to capital and to minimize the costs of capital (Eiteman et al, 2010). The most effective method for accomplishing this is to determine market liquidity and market segmentation. Market liquidity influences a firm’s securities while market segmentation influences its capital; firms must source their long-term debt and equity in the appropriate market, which includes highly illiquid; small capital; and segmented capital markets; to reduce the costs of capital, while increasing its availability (Eiteman et al, 2010). Highly illiquid domestic securities markets often lead to high capital costs and low availability; small capital markets produce more effective results because they are partially illiquid; and segmented markets are less favorable because of excessive regulatory control, political risk, and other market imperfections (Eiteman et al, 2010).
Budgeting and Operational Issues
Although global firms try to combat common issues that influence their financials in global markets, they may still encounter capital budgeting problems. Multinational capital budgeting is similar to domestic capital budgeting because it focuses on cash flows; however, several elements that do not exist domestically complicate the process. Common issues associated with multinational capital budgeting are linked to mandates for accounting for parent company cash flows such as the requirement to distinguish cash flows from subsidiaries, complications arising from separating financing activities; and recognizing the remittance of funds because of tax, legal, and political differentiations (Eiteman et al, 2010). Other multinational capital budgeting problems are associated with managerial strains such as anticipating multiple inflation rates; monitoring exchange rate changes for unanticipated direct effects on cash flows; and evaluating political risk (Eiteman et al, 2010).
In addition to capital budgeting issues, multinational companies may also encounter operational issues. The most common type of operational issue is associated with international trade financing. International trade financing is a method used to by multinational companies to finance imports and exports and usually involves the use of key trade documents such letters of credit or government programs designed to finance the activities such as the United States’ Export-Import Bank (Eiteman et al, 2010). However, issues may arise when multinational firms are tasked with identifying companies that are capable of producing the items they require within a timely manner and according to company specifications. Issues may also arise during the initial relationship establishment phase when the exporters are unaffiliated or unknown requiring firms to enter into sales contracts and risking noncompliance from exporters.
- Eiteman, David K, Arthur I Stonehill and Michael H Moffett. Multinational business finance.
