Multinational Enterprises
Lecture 1

 

Forms of Business Organizations

Goal of a business is to earn profits

  1. Sole Proprietorship - one person owns / operates business

    • Business is dissolved when owner dies

    • Most numerous business in the U.S.

    • Farms, restaurants, hotels, grocery stores, etc.

  2. Partnership - two or more people own a business

    • Accounting and law firms

    • General Partnership - other partners are liable for the actions of any partner, such as stealing, fraud, etc.

      • Creditors can go after other partners

      • Example - a partner secretly applies for a bank loan, steals the money, and leaves the country

    • Limited liability partnership - creditors cannot go after the personal assets of the partners

  3. Corporations

    • Approximately 20% of businesses are corporations, and they dominate businesses activity

    • Shareholders own the corporation through stock

    • Corporate managers should

      • Maximize stock prices

      • Maximize the shareholders' wealth

      • Maximize a firm's value

 

Corporations

 

  • Initial Public Offer (IPO) - a private company transforms into a corporation

    • Usually company's founder is a majority shareholder

    • Founder becomes a millionaire or billionaire over night

  • Charter - legal document that establishes a corporation as a legal person

  • Three parties

    • Shareholders - own the corporation

      • Meet once a year to elect the board of directors

      • One share equals one vote

      • Shareholder could be another corporation

      • Usually majority shareholder elects himself or herself to the board of directors

    • Board of Directors - control the corporation

      • Set corporate policy

      • Declare dividends

      • Appoint the upper management to run the day to day operations of the corporation

  • Benefits of a corporation

    • Raise substantial amount of financial capital

      • Enter foreign countries and dominate international trade

      • Have special departments that handle operations in a foreign country

      • Requires many specialists in laws, taxes, etc. for different countries

    • Has limited liability

      • Stockholders are not liable for a corporation's debt

      • They can only lose the value of stock, i.e. their investment

    • Can easily transfer ownership

      • Stockholder can buy or sell shares on a stock exchange

    • Have continuity of life; they can live forever theoretically

    • Do not have mutual agency relationship

      • Shareholders cannot bind a corporation to contracts

  • Problems of corporations

    • Corporations are heavily regulated

      • File many reports with government

      • Corporations may encourage this!

      • Makes it more difficult for a new company to enter a market

    • Corporations are taxed twice

      • Corporations pay taxes on profits, i.e. net income

      • Stockholders receive profit from corporation as dividends

      • Stockholder’s income subject to income taxes

  • Types of stock

    • Common stock - shareholders can vote at stockholder meetings

    • Preferred stock - shareholders cannot vote at stockholder meetings

      • Preferred shareholders receive their dividends before common shareholders

      • If corporation is liquidated, then preferred shareholders come before the common shareholders

    • Why issue preferred stock?

      • Common shareholders do not dilute their control of the corporation by issuing preferred stock

  • Types of preferred stock

    • Cumulative preferred stock - stockholders receive all past due dividends before common stockholders

    • Protective preferred stock - corporation must deposit part of its profits into a fund to pay preferred stockholders

    • Redeemable stock - corporation has the right to buy back the stock in the future

    • Convertible stock - a preferred stockholder can convert their stock into common stock on a specific date

  • Bond - a standardized loan to a corporation

    • Investors can easily buy / sell bonds in a market

    • Bondholder has two rights

      • Corporation must pay interest

      • Corporation must repay the bond's face value on the maturity date

    • If a corporation bankrupts and is dissolved

      • Must pay taxes first

      • Bondholders and other loans come second

      • Preferred shareholders come third

      • Common shareholders are last

  • Corporations create complex structures

    • Reason - regulations, taxes, and lawsuits

    • If lawyers sue a corporations subsidiary, then the parent corporation can spin off the subsidiary, and let the legal sharks eat it

    • Example - a judge sued a dry cleaner's for $65 million for losing his pants

    • Example - Halliburton owned Brown and Root

      • Brown and Root was liable for asbestos claims

      • Halliburton sold it off to protect itself

    • Corporations establish headquarters in tax havens

      • Bahamas and Cayman Islands - low taxes, little regulations, and strong confidentiality laws

      • Corporation moves assets and liabilities around to reduce tax burden

    • Tax evasion

      • A business or person did an activity that generates a tax

      • If he or she does not pay, then this is tax evasion

      • The punishment is fines and prison

      • Greece has a severe tax evasion problem

    • Tax avoidance

      • A business or person structures an activity to avoid legally paying a tax

      • Since the 2007 Great Recession - tax authorities are becoming aggressive at collecting for tax avoidance

      • Example - tax inspectors in Italy board yachts as the dock in Italian ports

  • Stockholders want a good return on their investment

    • shareholder return = dividend yield + capital gains

    • Managers can influence dividend yield

      • Usually 2% per year

      • dividend yield = 100*dividend / stock price

    • Managers have little influence on capital gains

      • Usually 12% per year

      • Severe stock market declines can cause capital losses

      • Examples - many stocks took a beating in 2000 and 2008

      • capital gains = 100*(stock price2 - stock price1)/stock price1

    • Example

      • Apple's currently stock price is $669.72

      • Apple paid a $266 per share dividend, which is the first since 1995

      • Apple's stock price was $381.32 a year ago

      • Dividend yield is 0.397%

      • Capital gain is 75.63%

      • Total return is 76.0%

Corporate Fraud

 

1. Enron bankrupted in 2001

  • Special Purpose Entities (SPE)

    • Companies / subsidiaries

    • Shell company - exists only on paper, or office has one desk and filing cabinet

    • Off-balance sheet companies

  • Enron used SPEs to improve its financial statements artificially

    • Enron invested in many power plants around the world

    • Some investments went bad, and Enron sold its bad investments to its SPEs

      • Balance sheet looks better

      • Can get more loans

      • Enron invested in more power plants around the world

    • Enron hid $25 billion in debt

  • SPE

    • Funded by Enron stock

      • As Enron stock price rose, the SPE's finances were healthy

      • Enron's stock peaked at $90 per share

      • As Enron stock price fell to less than a $1 in 2000, then SPE's accumulated large losses

      • Enron hid the losses

      • Recession occurred in 2001

      • A recession always reveals an organization's weakness

    • Enron tried to get more bank loans

    • Enron employees had their pensions invested in Enron stock

  • Most overlooked the SPEs, including the following:

    • Auditor, Arthur Anderson

    • Law firm

    • Regulators such as the Securities and Exchange Commission (SEC)

  • U.S. government passed the new law, Sarbanes-Oxley Act in 2002

    • CFOs and CEOs must sign the firm's financial statements

    • Increase transparency

  • Transparency - outsiders can accurately assess a firm's true finances

    • Enron - "a black box"

    • Non-transparent government - tends to be corrupt

      • Laws and rules are not written down; tend to be vague, etc.

      • Bureaucrats have wide discretion to approve licenses, etc.

  • Did the new federal law fix any thing?

    • The scale of fraud became much larger during the 2008 Financial Crisis

    • The United States experienced a real estate housing bubble, 2000 - 2007

    • Lehman Brothers used exotic derivatives and bought expensive real estate at the peak of the bubble

      • Credit Default Swaps

      • Collateralized Debt Obligations

    • Bank and bond debt was $768 billion

    • Assets were $639 billion, but falling fast as the property bubble deflated

    • Lehman Brothers closed its door after 158 years of business

2. Countries differ in corporate structure and planning

  • U.S. corporations focus on short-term profits

    • Problems with corporate fraud

  • Japanese Keiretsu - tend to focus on long-term profits and market shares

    • Keiretsu - a conglomerate of many companies with a bank as a member

    • Bank grants low interest loans to partner companies

    • Similar in South Korea, Germany, and Russia

  • Popular in the former communistic countries

    • Government forms a joint venture company with foreign companies

    • Foreign companies bring technology and management expertise

    • Government retains control over company

    • Prone to corruption - if company cannot compete, then government uses its power to protect company

3. Principal-Agent Problem - two related parties have different incentives which conflict with each other

  • Corporation separates the managers from the owners (i.e. stockholders)

    • Managers are supposed to:

      • Maximize profits

      • Maximize the return to the shareholders

      • Increase shareholder value

    • Managers may not act in the best interest of the owners

      • Managers want high salaries, benefits, etc.

    • Example 1

      • U.S. Investment banks were partnerships; very careful with money

      • During 1990s, investment banks were converted to corporations

      • Managers gambled and took high risks

      • Shareholders lost their stock value during 2008 Financial Crisis

    • Example 2 - GM cancelled its stock, and its shareholders lost everything in 2008

  • A family owned corporation may reduce the principal-agent problem

    • Stockholders and top management are the same people

    • Examples: Walmart and Microsoft

    • Tend to earn high returns

    • Management has better vision, oversight, etc.

 

Law of Comparative Advantage

1. Multinational corporations

  • Multinational corporation - corporation is incorporated in one country, and has one or more operations and offices in foreign countries

    • British Petroleum, General Electric, Toshiba, and Wal-Mart

  • Multinational enterprise - includes businesses where government forms a joint venture with a corporation

  • Enterprises go international to make profits

    • Have a choice - export to country or relocate production to a foreign country

    • Why does a firm chose investment over exports?

      1. Government offers subsidies and tax breaks

        • Dubai and China have free trade zones

        • Few regulations and low taxes

      2. Gain access to technology from another country

        • India has software programmers

        • Indians work for lower wages than Americans and Europeans

      3. A company that produces within a foreign country automatically avoid tariffs and import quotas

      4. Reduce transportation costs - more processing in closer proximity

        • Example - sugarcane is bulky to ship

        • Sugar mills extract and purify the sugar, which is exported to foreign markets

      5. Gain access to new markets and more consumers

        • Coca-Cola and McDonald's

      6. A company investing in a foreign country could lead to future expansion

        • A company opens a branch in Moscow, Russia. Company could expand to other Russian cities or other Russian-speaking countries

      7. A company could reduce economic exposure

        • Economic exposure - changes to a company's profits because an economic factor changed, such as inflation, interest rate, or exchange rate

        • If a country produces and sells within the same country, changes in the exchange rate impact its profits less

      8. A company diversifies its business by expanding into foreign countries

        • Some markets grow quickly, while other markets experience weak growth

      9. Require important raw materials for production

        • Example - Bolivia possesses half the world's supply of lithium, which is used to make laptop batteries

        • Firms relocate there to extract and purify lithium

      10. Reduce production costs - many companies relocated to China and Mexico, because the wages are lower relative to productivity

      11. A company outsources its production to another company to lower its costs

        • Example, Microsoft outsourced its production of X-box consoles to Flextronics, a Singaporean company

        • Flextronics outsourced production to a Chinese manufacturing plant

      12. Political Safety - companies relocate to countries that are business friendly

        • Bahamas, Dubai, Singapore, etc.

2. Markets are defined as two types

  • Mature economies - United States and Europe

    • Very competitive

    • Difficult to make money

  • Emerging Market Economies - countries that are opening up to markets

    • China, India, and Mexico - opening to more markets

    • Emerging markets can be very profitable, but entail greater risk

  • Requirements

  • Open Market place

    • Government must allow free markets and allow free movement of capital, labor, and technology

  • Strategic Management

    • Management has the ability to compete and develop new products and services

    • Adapt products and services to different cultures

  • Access to capital

    • International activities require financing

    • Government must allow the free movement of money

    • Corporations can issue more stock, bonds, or receive bank loans

3. Multinational firms are more complicated

  • Businesses transfer resources like machines, equipment, and labor and transfers products and services between different countries

  • Enterprises are exposed to exchange rate risks and credit risks

  • Enterprises have other exposures too like country risk (or political risk)

  • Example 1 - Hugo Chavez in Venezuela nationalized foreign companies

    • Government seizes assets and companies without compensation

  • Example 2 - Kazakhstan - former communistic country

    • President Nazarbayev opened the economy up to free markets in early 1990s

    • After 2008, Kazakhstan is reverting to Soviet rules and practices

    • Kazakh government nationalized a petroleum company

    • International investment plummeted

4. Comparative advantage - how two countries can benefit from trade, even though one country could be large and produce everything

  • David Ricardo

  • Show how two countries benefit from trade

  • Assumptions

    • Both countries are at full employment (i.e. on production possibilities curve)

    • PPCs are straight line (no losses occur when moving resources from industry to industry

      • Works with curved PPCs

    • U.S.A. and Mexico produce both tomatoes and cars

      • No trade - set production at the half way point

Using PPCs to show gains to trade

  • Autarky - no trade

    • U.S. produces 25 tomatoes and 50 cars

    • Mexico produces 30 tomatoes and 15 cars

    • Total production is 55 tomatoes and 65 cars

  • Comparative advantage - countries specialize in production of products which they have low opportunity costs

    • Important because a large country like the U.S. that can produce everything at low cost can still benefit from trade with a small country with higher costs

    • Related to slopes of the PPC

    • Complete specialization - U.S.A. produces all cars and Mexico produces all tomatoes

      • PPCs are straight lines

    • Total production is 100 cars and 60 tomatoes

      • Gain in production of 35 cars and 5 tomatoes

  • Need more trade theory to show how countries divide up the extra production

  • Limitations

    • Capital and technology can easily flow from one country to another

    • Outsourcing - a firm sends out part of its production to another firm in another country

    • Communication and transportation costs are decreasing

 

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