Professional Documents
Culture Documents
internationally as well. In fact, the firm may have a more distinct advantage in markets that have
less advanced technology.
EXAMPLE In recent years, Google acquired businesses in Canada, China, Finland, Greece,
Israel, South Korea, Spain, and Sweden. It is effective at using its technology to improve the
capabilities of other businesses. In this way, it expands its technology internationally.
React to trade restrictions: In some cases, MNCs use DFI as a defensive rather than an
aggressive strategy. Specifically, MNCs may pursue DFI to circumvent trade barriers.
EXAMPLE Japanese automobile manufacturers established plants in the United States in
anticipation that their exports to the United States would be subject to more stringent trade
restrictions. Japanese companies recognized that trade barriers could be established that would
limit or prohibit their exports. By producing automobiles in the United States, Japanese
manufacturers could circumvent trade barriers.
Diversify internationally: Since economies of countries do not move perfectly in tandem over
time, net cash flow from sales of products across countries should be more stable than
comparable sales of the products in a single country. By diversifying sales (and possibly even
production) internationally, a firm can make its net cash flows less volatile. Thus, the possibility
of a liquidity deficiency is less likely. In addition, the firm may enjoy a lower cost of capital as
shareholders and creditors perceive the MNCs risk to be lower as a result of more stable cash
flows.
EXAMPLE Several firms experienced weak sales because of reduced U.S. demand for their
products. They responded by increasing their expansion in foreign markets. AT&T and Starbucks
pursued new business in China. Cisco Systems expanded substantially in China, Japan, and
South Korea.
Cost-Related Motives
MNCs also engage in DFI in an effort to reduce costs. The following are typical motives of
MNCs that are trying to cut costs:
Fully benefit from economies of scale: A corporation that attempts to sell its primary product
in new markets may increase its earnings and shareholder wealth due to economies of scale
(lower average cost per unit resulting from increased production). Firms that utilize much
machinery are most likely to benefit from economies of scale.
EXAMPLE Newark Co. has developed technology to create software. The development costs
are high, but once the software is created, there is very little cost of distribution. Newark realized
that its development of technology would only be feasible if it could sell a very large amount of
software that it develops. However, it had already expanded throughout the United States and
had limited growth potential there. It decided to created subsidiaries in foreign countries that
could sell software there. In this way, it was able to increase its total production, which allowed it
to reduce its average cost of production.
Use foreign factors of production: Labor and land costs can vary dramatically among
countries. MNCs often attempt to set up production in locations where land and labor are cheap.
Due to market imperfections such as imperfect information, relocation transaction costs, and
barriers to industry entry, specific labor costs do not necessarily become equal among markets.
Thus, it is worthwhile for MNCs to survey markets to determine whether they can benefit from
cheaper costs by producing in those markets.
EXAMPLE Mexico has been a major target for MNCs that are seeking to reduce their cost of
production. Many U.S.based MNCs, including Black & Decker, Eastman Kodak, Ford Motor
Co., and General Electric, have established subsidiaries in Mexico to achieve lower labor costs.
Asia has also attracted much direct foreign investment. Honeywell has joint ventures in countries
such as Korea and India where production costs are low and has also established subsidiaries in
Malaysia. Genzyme Corp. recently invested about $100 million in China for research and
development and biotechnology production.
Use foreign raw materials: Due to transportation costs, a corporation may attempt to avoid
importing raw materials from a given country, especially when it plans to sell the finished
product back to consumers in that country. Under such circumstances, a more feasible solution
may be to develop the product in the country where the raw materials are located.
Use foreign technology: Corporations are increasingly establishing overseas plants or
acquiring existing overseas plants to learn about unique technologies in foreign countries. This
technology is then used to improve their own production processes and increase production
efficiency at all subsidiary plants around the world.
EXAMPLE Cisco recently planned a $1 billion investment into Russia to create innovative
business ideas. Cisco has previously invested heavily in India and other markets to tap into
unique technologies and innovation.
React to exchange rate movements: When a firm perceives that a foreign currency is
undervalued, the firm may consider DFI in that country, as the initial outlay should be relatively
low.
EXAMPLE Wyoming Co. is a distributor of ski equipment that wants to expand its business into
snowmobiles. Most of the production would be exported to Canadian retail stores and invoiced
in dollars. It anticipates that the Canadian dollar will weaken against the U.S. dollar over the next
several years, which would increase the cost to Canadian stores that purchase its exports. Its
main competitor of this new business would be a firm in Canada. Wyoming Co. decides to
acquire the firm in Canada rather than export products to Canada. Consequently, it can avoid the
adverse exchange rate effects, and in fact can benefit.
Then, earnings from the new operations can periodically be converted back to the firms
currency at a more favorable exchange rate.
Challenges to FDI
Governments are less anxious to encourage DFI that adversely affects locally owned companies,
unless they believe that the increased competition is needed to serve consumers. Therefore, they
tend to closely regulate any DFI that may affect local firms, consumers, and economic
conditions.
Protective Barriers: When MNCs consider engaging in DFI by acquiring a foreign company,
they may face various barriers imposed by host government agencies. All countries have one or
more government agencies that monitor mergers and acquisitions. These agencies may prevent
an MNC from acquiring companies in their country if they believe it will attempt to lay off
employees. They may even restrict foreign ownership of any local firms.
Red Tape Barriers: An implicit barrier to DFI in some countries is the red tape involved,
such as procedural and documentation requirements. An MNC pursuing DFI is subject to a
different set of requirements in each country. Therefore, it is difficult for an MNC to become
proficient at the process unless it concentrates on DFI within a single foreign country. The
current efforts to make regulations uniform across Europe have simplified the process required to
acquire European firms.
Industry Barriers: The local firms of some industries in particular countries have substantial
influence on the government and will likely use their influence to prevent competition from
MNCs that attempt DFI. MNCs that consider DFI need to recognize the influence that these local
firms have on the local government.
Environmental Barriers: Each country enforces its own environmental constraints. Some
countries may enforce more of these restrictions on a subsidiary whose parent is based in a
different country. Building codes, disposal of production waste materials, and pollution controls
are examples of restrictions that force subsidiaries to incur additional costs. Many European
countries have recently imposed tougher antipollution laws as a result of severe problems.
Regulatory Barriers: Each country also enforces its own regulatory constraints pertaining to
taxes, currency convertibility, earnings remittance, employee rights, and other policies that can
affect cash flows of a subsidiary established there. Because these regulations can influence cash
flows, financial managers must consider them when assessing policies. Also, any change in these
regulations may require revision of existing financial policies, so financial managers should
monitor the regulations for any potential changes over time. Some countries may require
extensive protection of employee rights. If so, managers should attempt to reward employees for
efficient production so that the goals of labor and shareholders will be closely aligned.
Ethical Differences: There is no consensus standard of business conduct that applies to all
countries. A business practice that is perceived to be unethical in one country may be totally
ethical in another. For example, U.S.based MNCs are well aware that certain business practices
that are accepted in some less developed countries would be illegal in the United States. Bribes
to governments in order to receive special tax breaks or other favors are common in some
countries. If MNCs do not participate in such practices, they may be at a competitive
disadvantage when attempting DFI in a particular country.
Political Instability: The governments of some countries may prevent DFI. If a country is
susceptible to abrupt changes in government and political conflicts, the feasibility of DFI may be
dependent on the outcome of those conflicts. MNCs want to avoid a situation in which they
pursue DFI under a government that is likely to be removed after the DFI occurs.
International Portfolio Investment:
Portfolio investment is defined as cross border transactions and positions involving debt or
equity securities, other than those included in direct investment or reserve assets. Investment
fund shares or units (i.e., those issued by investment funds) that are evidenced by securities and
that are not reserve assets or direct investment are included in portfolio investment.
c. Many Different alternatives- In today's investment market, there are many different options
for investors to choose from if they want to get involved with international investment like
mutual funds, exchange traded funds (ETFs), and a number of other investment vehicles.
currency weakens compared to the U.S. dollar, this weakness reduces investment return because
earnings translate into smaller number of dollars.
2. Spectacular changes in market value:
Foreign markets, like all markets, can experience dramatic changes in market value. One way to
reduce the impact of these price changes is to invest for the long term and try to ride out sharp
upswings and downturns in the market. Individual investors frequently lose money when they try
to "time" the market in the United States and are even less likely to succeed in a foreign market.
When investors time the market, they have to make two smart decisions -- deciding when to
get out before prices fall and when to get back in before prices rise again.
3. Political, economic and social risks:
Political risk is sometimes defined as a country's willingness to maintain a hospitable climate for
outside investments. Economic risk, on the other hand, is the ability of a country to pay its debts.
The economic and political states of a country are codependent. If the economy of a country is
strong but its political state is hostile -- or vice versa-- it ceases to be appealing to foreign
investors. The political decisions made in a country may result in its instability, causing the
weakening of the economy and creating losses for both local and foreign investors. It is difficult
for investors to understand all the political, economic, and social factors that influence foreign
markets. These factors provide diversification, but they also contribute to the risk of international
investing.
4. Deficiency in of liquidity:
Foreign markets may have lower trading volumes and fewer listed companies. They may only be
open a few hours a day. Some countries restrict the amount or type of stocks that foreign
investors may purchase. The investors may have to pay premium prices to buy a foreign security
and have difficulty finding a buyer when they want to sell.
5. Dependence on Foreign Legal Remedies:
Legal processes in one country may not necessarily apply to the other country in which
investment is based if investors encounter a problem with an investment made abroad. In such
cases investors will be forced to rely on available legal remedies in the company's home country,
which may prove expensive.
6. Insufficient Information:
Many foreign companies do not provide investors with the same type of information. Acquiring
up-to-date information about a foreign company can not only take time and money, it also often
difficult to come by. As a result, many foreign investors cannot make informed decisions about
their investments of choice. Additionally, some companies may post their information in their
local language and not in English. Foreign investors therefore have the added cost of translating
this information to English in an attempt to get all the necessary fact about the investment.
7. Different market operations:
Foreign markets often operate differently from the major U.S. trading markets. For example,
there may be different periods for clearance and settlement of securities transactions. Rules
providing for the safekeeping of shares held by custodian banks or depositories may not be as
well developed in some foreign markets, with the risk that investors shares may not be protected
if the custodian has credit problems or fails.
Major components of Foreign Direct Investment (FDI) are presented in the Table 14.1. The table
shows that reinvestment is the main component of FDI inflow, followed by equity and intracompany borrowing.
Figure shows the sector-wise distribution of foreign and joint venture projects during FY 201314.
Form the Figure it is observed that the service sector comprises the major share of registration
(79.26%) percent. Other important sectors are engineering (11.17%), agro-industry (3.54%) and
textile industry (2.94%).
Country wise Joint Venture and Foreign Investment: The sources of foreign and joint venture
projects registered in FY 2013-14 were 24 countries/economies from different regions of the
world. Proposed amount of investment in South-East Asia is the highest, followed by South, East
and West Asia, European Union, North America and CIS region. The source-wise distribution of
the BOI-registered new projects from FY 2006-07 to FY 2013-14 (52 countries) is presented in
Table below.
(In
Million
US
Dollar)