EunResnick

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Chapter Sixteen
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Foreign Direct Investment
INTERNATIONAL FINANCIAL MANAGEMENT
Chapter Objective This chapter discusses
various issues associated with foreign direct
investments by MNCs, which play a key role in
shaping the nature of the emerging global economy.
EUN / RESNICK
Second Edition
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Chapter Outline

• Global Trends in FDI
• How do Firms Conduct International Business?
• Why Do Firms Invest Overseas?
• Cross-Border Acquisitions
• Political Risk and FDI

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Global Trends in FDI
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International Business

• Exporting
• Licensing agreement
• Joint venture
• FDI

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Exporting

• Preferred method of entry into global
  marketplace.
• Advantages of exporting?
• Disadvantages of exporting?

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Licensing

• Find local company and license it to produce
  companys products for the local market.
• Advantages of licensing?
• Disadvantages of licensing?

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Joint Venture

• Find local firm with which you form a new
  jointly-owned subsidiary that produces companys
  products.
• Advantages of joint ventures?
• Disadvantages of joint ventures?

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Foreign Direct Investment

• Company owns production facilities in foreign
  countries.
• Advantages of FDI?
• Disadvantages of FDI?

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FDI

• Greenfield Investment
• Building new facilities from the ground up.
• Cross-Border Acquisition
• Purchase of existing business.
• Historically, Cross-Border Acquisition represents
  40-50 of FDI flows.
• Cross-border acquisitions are a politically
  sensitive issue
• Greenfield investment is usually welcome. Why?
• Cross-border acquisition is often unwelcome. Why?

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Why Do Firms Invest Overseas?

• Trade Barriers
• Labor Market Imperfections
• Intangible Assets
• Vertical Integration
• Product Life Cycle
• Shareholder Diversification

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Trade Barriers

• What does free trade mean?
• How can government actions to restrict free trade
  lead to market imperfections? Examples.
• Trade Barriers can also arise naturally due to
  high transportation costs, particularly for low
  value-to-weight goods.

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Labor Market Imperfections

• What are factors of production?
• Why is the labor market the least perfect of the
  markets for factors of production?
• How do these market imperfections lead to foreign
  investments?

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Labor Market Imperfections
Persistent wage differentials across countries
exist. This is one on the main reasons MNCs are
making substantial FDIs in less developed nation.
(2001)
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Intangible Assets

• Coca-Cola has a very valuable asset in its
  closely guarded secret formula.
• To protect that proprietary information,
  Coca-Cola has chosen FDI over licensing. Why?
• What is Cokes real intangible asset?

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Vertical Integration

• What is vertical integration?
• Vertical integration may be backward or forward
• Backward integration e.g. a furniture maker
  buying a logging company.
• Forward integration e.g. a U.S. auto maker
  buying a Japanese auto dealership.
• How could desire for vertical integration lead a
  company to FDI.

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Product Life Cycle

• U.S. firms develop and produce new products at
  home for the domestic market. Pricing power?
• Once demand levels off the firm exports to expand
  into new markets overseas. Pricing power?
• When would FDI become the appropriate method of
  reaching those markets? Pricing power?

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Political Risk and FDI

• Unquestionably this is the biggest risk when
  investing abroad.
• Does the foreign government uphold the rule of
  law?
• A big source of risk is the non-enforcement of
  contracts.

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Political Risk

• Transfer Risk
• Uncertainty regarding cross-border flows of
  capital.
• Operational Risk
• Uncertainty regarding host countries policies on
  firms operations.
• Control Risk
• Uncertainty regarding ultimate control of the
  company.

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Hedging Political Risk

• Geographic diversification
• Why might this help hedge political risk?
• Minimize exposure
• Form joint ventures with local companies.
• Why might this hedge political risk?
• Join a consortium of international companies to
  undertake FDI.
• Why might this hedge political risk?
• Finance projects with local borrowing.
• Why?

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Hedging Political Risk

• Insurance
• The Overseas Private Investment Corporation
  (OPIC) a U.S. government federally owned
  organization, offers insurance against
• The inconvertibility of foreign currencies.
• Expropriation of U.S.-owned assets.
• Destruction of U.S.-owned physical properties due
  to war, revolution, and other violent political
  events in foreign countries.
• Loss of business income due to political violence