Chapter 20 Outline

Introduction

As the opening case makes clear, this chapter focuses on financial management in the international business. Included within the scope of financial management are three sets of related decisions:

• Investment decisions, decisions about what activities to finance.

• Financing decisions, decisions about how to finance those activities.

• Money management decisions, decisions about how to manage the firm's financial resources most efficiently.

The opening case describes Procter & Gamble's approach toward these decisions. By managing investing, financing, and money management decisions centrally through its global treasury function, P&G has realized considerable cost economies. These economies help P&G compete more effectively in the global marketplace.

In an international business, investment, financing, and money management decisions are complicated by the fact that countries have different currencies, different tax regimes, different regulations concerning the flow of capital across their borders, different norms regarding the financing of business activities, different levels of economic and political risk, and so on. Financial managers must consider all these factors when deciding which activities to finance, how best to finance those activities, how best to manage the firm's financial resources, and how best to protect the firm from political and economic risks (including foreign exchange risk).

Good financial management can be an important source of competitive advantage. This is implicit in the opening case, where good financial management helps P&G attain cost economies and lower its overall cost structure. For another example, consider FMC, a Chicago - based producer of chemicals and farm equipment. FMC counts on overseas business for 40 percent of its sales. FMC attributes some of its success overseas to aggressive trading in the forward foreign exchange market. By trading in currency futures, FMC can provide overseas customers with stable long-term prices for three years or more, regardless of what happens to exchange rates. Ralph DelZenero, FMC's foreign exchange specialist, says, "Some of our competitors change their prices on a relatively short-term basis depending on what is happening with their own exchange rate . . . We want to provide longer-term pricing as a customer service--they can plan their budgets knowing what the numbers will be--and we can hopefully maintain and build our customer base." FMC also offers its customers the option of paying in any of several currencies as a convenience to them and as an attempt to retain customers. If customers could pay only in dollars, they might give their business to a competitor that offered pricing in a variety of currencies. By adopting this policy, FMC deals with "the hassle of foreign exchange movements," says Mr. DelZenero, so its customers don't have to. By offering customers multicurrency pricing alternatives, FMC implicitly accepts the responsibility of managing foreign exchange risk for its business units that sell overseas. It has set up what amounts to an in-house bank to manage the operation, monitoring currency rates daily and managing its risks on a portfolio basis. This bank handles more than $1 billion in currency transactions annually, which means the company can often beat the currency prices quoted by commercial banks.¹

Chapter 12 talked about the value chain and pointed out that creating a competitive advantage requires a firm to reduce its costs of value creation and/or add value by improving its customer service. P&G and FMC show how good financial management can help both reduce the costs of creating value and add value by improving customer service. By reducing the firm's cost of capital, eliminating foreign exchange losses, minimizing the firm's tax burden, minimizing the firm's exposure to unnecessarily risky activities, and managing the firm's cash flows and reserves in the most efficient manner, the finance function can reduce the costs of creating value. As the example of FMC illustrates, good financial management can also enhance customer service, thus adding value.

We begin this chapter by looking at investment decisions in an international business. We will be most concerned with the issue of capital budgeting. Our objective is to identify the factors that can complicate capital budgeting decisions in an international business, as opposed to a purely domestic business. Most important, we will discuss how such factors as political and economic risk complicate capital budgeting decisions.

Then we look at financing decisions in an international business, focusing on the financial structure of foreign affiliates--the mix of equity and debt financing. Financial structure norms for firms vary widely from country to country. We will discuss the advantages and disadvantages of localizing the financial structure of a foreign affiliate to make it consistent with the norms of the country in which it is based.

Next we examine money management decisions in an international business. We will look at the objectives of global money management, the various ways businesses can move money across borders, and some techniques for managing the firm's financial resources efficiently.

The chapter closes with a section on managing foreign exchange risk. Foreign exchange risk was discussed in Chapter 9, but there our focus was on how the foreign exchange market works and the forces that determine exchange rate movements. In this chapter, we focus on the various tactics and strategies international businesses use to manage their foreign exchange risk.