Financial Structure And Debt Summary

1. Optimal financial structure and the MNE

To get the best financial structures a MNE should take into account four different variables. We are going to develop these 4 main variables:

a. Availability of capital

MNE has a big advantage compared to local firms because they have an access to the international market and they can lower their costs of equity and debt.

b. International diversification of cash flows

Because the cash flows of MNE are internationally diversified they can support higher debt ratios.

c. Foreign exchange risk and the cost of debt

When asking for credits abroad, and specially to countries in which the currency used is different, the MNE has the risk of losing money due to the currency exchange ratios. When the credit has to be repaid the MNE has to pay both the nominal interest plus the increase or decrease in the currency exchange ratio.

d. Expectations of international portfolio investors

In the international market, an acceptable debt ratio is up to 60% and any higher ratio is difficult to sell. This is due to the standards used in the Amercian and English markets.

3. Financial structure of foreign subsidiaries :

The main important objective for a MNE is to minimize globally the cost of capital. However, a MNE is composed of many different subsidiaries in different countries all over the world and each country has its own norms, rules and legal constraints. Therefore, the MNE faces the problem of whether to follow the procedures of the specific country in which the subsidiary is located, or to follow more global financial structures.

a. Advantages to conform to local norms (localization)

- It helps to improve the image of subsidiaries.

- Too much debt is not good for the investors as they find it too risky to invest.

- Not enough debt can be interpreted as being an insensitive MNE to local monetary policy.

- Local debt positions you at the same level of your competitors being no unfair competition.

b. Disadvantages to conform to local norms (localization):

- Cannot overcoming imperfection in national capital market

- The consolidated balance sheet may have little sense as is not strictly attached to any specific procedure.

- Local debt must be guaranteed by the parent firm.

c. Solution

- A possible solution could be to minimize both the subsidiaries and the parent firms cost of capital as the international and the domestic firm pursue the same objective.

- The MNE has also to consider the trade off that exists between the risks and the costs of the different subsidiaries.

- It is not so easy for a MNE to conform to international market but it could be something feasible.

d. Other sources of funding for foreign subsidiaries

An MNE has other possibilities to raise funds. The alternative can be of two different kinds: external or internal.

a.Internal sources of funding:

- The equity investment which can bring cash or real goods to the company.

- The debt stay however the best for subsidiaries

b. External sources of funding

- The subsidiary can get