Global financial management
Question 7: If capital markets were perfect, that is, capital could move freely across national borders, would MNCs still exist? Why? Or, why not? . Perfect capital market is a market in which there are never any arbitrage opportunities. Perfect capital markets enjoy an array of assumptions, including no cost to bankruptcy, infinitely divisible financial assets and liabilities, no transaction cost. Pursuing a selected optimal capital structure would allow minute adjustments, the issuance or redemption of small amounts.
The perfect market has conditions: it must have a large number of sellers and buyers, standardized products where its prices are given, it can enter the market freely and can also exit it freely. When there is perfect capital markets, resources will be more mobile and therefore the inflation rates, interest rates, and wages among countries would be more similar under conditions of perfect market, thereby making it easier to move the resources to those countries that are willing to pay higher prices for them.
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The concept of the multinational corporation is an enterprise that carries on business operations in more than one country. It extends its manufacturing and marketing operations through a network of branches and subsidiaries which are known as its foreign affiliates. Any corporation that is quoted on the world’s many stock exchanges or seek to become publicly held need investors to buy their shares.
In addition, investors only seek to hand over their money to firms that can help the money grow. Therefore, the main purpose of MNC executives and board members is to figure out how they can maximize the wealth of their shareholders. When managers make multinational finance decisions that maximize the overall present value of future cash flows, they maximize the firm’s value, and hence shareholder wealth. More specifically, it reflects the market’s evaluation of the firm’s erspective earnings stream over time, the riskiness of this stream, the dividend policy of the firm, and quality factors of the firm’s future activities, such as growth of sales, stability, and diversification. However, there is an agency problem of multinational companies, because the managers of the foreign subsidiary may also have other incentives than looking after the money of the company’s owners, what creates a conflict of interest between managers and stockholders.
Agencies problem may be larger in MNCs: The culture in the local areas of foreign subsidiaries may not be in line with the goals of the MNC. Also, many MNCs are so large that even relatively small agency problems can be inflated. Local tax laws can be harsh on international money transactions. Thus, local managers that are unaware of such laws might initiate projects that seem profitable, but end up costing the MNC money once the profit is remitted to the parent company. Finally, some countries have rigid labour markets.
In these countries in can be hard to fire a manager that does not comply with the goals of the MNC. In order to achieve the firm’s primary goal of maximizing stockholder wealth, the financial manager performs a number of important functions. The three major functions of financial management are financial planning and control, the efficient allocation of funds among various assets (investment decisions) and the acquisition of funds on favorable terms (financing decisions).
Moreover, multinational companies perform better than domestic companies because they have market imperfections, a better risk-return tradeoff, portfolio effect, comparative advantage, internationalization advantage, economies of scale, and a higher valuation. In conclusion, in order for MNCs to still exist while there is perfect capital market MNCs will have to compete with a hard competition and have to manage for a harder competition because they might have problems if they don’t manage well and offer more diversification.