Ways a Multinational Can Enhance Its Value through its Financial System:

Text points that this value exists only because Government actions: these include taxes, regulations, and foreign exchange policies.

TAX ARBITRAGE: Shift Profits from high (income) tax nations to low tax nations.

- Transfer Pricing: set prices high when shipping goods from a low tax affiliate to a high tax affiliate. Tax Enforcers require, whenever, possible that affiliates charge one another ARMS-LENGTH PRICES.

Can use Tariffs to reduce Value of this Strategy.

 
Reinvoicing Centers (Tax Havens): Barely allowed now. The case of U.S. Gypsum. P361.

- Fees and Royalties
 

FINANCIAL MARKETS ARBITRAGE: Shift excess funds from nations with loose credit policies to those with tight policies, circumvent exchange controls, and borrow in nations with the loosest credit policies.

Leading and Lagging: shrinking or expanding the trade credit to affiliates.

(by changing the float period)

Ex: U.S. sell $12 million a year to its Spanish affiliate. Requires payment in 90 days.

Spain imposes higher rates to "protect' the peseta. Spanish affiliate suffers cash crunch. What can the MNC do?

Intercompany Loans:

Used to

1) finance foreign operations and

2) to transfer funds.

Can be an effective weapon against exchange controls, where the local Govt. refuses to allow local currency "profits" to be "repatriated. (it imposes currency controls)

I. Direct Loans: Parent firm or other affiliate lends the funds. May be difficult to recover these funds (or the interest) in the future.

II. "Fronting Loans" (Back-to-Back Loans): a U.S. bank makes the loan, but the loan is "guaranteed" by the parent firm's making a large deposit in the bank. The idea is that a local Govt. is less likely to interfere with a loan agreement with a major international bank than with a direct loan agreement. The Local Govt. may also treat the interest on the bank loan more favorably than the interest on a direct loan.

Does this loan improve the affiliate's credit rating? There is the perception that the affiliate has obtained the loan using its own credit worthiness.

(maybe this is like a parent co-signing a teenager's first car loan?)

III. Parallel Loans:

Two MNCs arrange reciprocal loans to the other's affiliate. Two examples in the text:

1) Where the Parent firms are in one another's countries. Ex. An American Firm wants to lend funds to its subsidiary in Spain, but is worried about the Spanish Govt. imposing currency controls. A Spanish MNC has a U.S. Affiliate - it can, with the right motivation, withdraw funds (dollars) from its affiliate, convert them to Pesetas and loan them to the U.S. MNC's Spanish affiliate.

2) In many LDCs (like Brazil) there may be no LDC MNC with a U.S. affiliate. In such cases, after currencies are blocked, Two U.S. MNC's with Brazilian affiliates can arrange local currency loans between one another's affiliate. The affiliate with the excess cash to be repatriated can loan these funds to an affiliate that is short of local currency.

DIVIDENDS:

Once the affiliate becomes profitable, the parent firm usually requires the affiliate to pay the parent a dividend (related to the amount of its equity invest or the earnings return on the equity.

Many local governments resist the MNC taking money out. (see page 18 for Example of General Motors and Australia). One reason to favor debt over equity financing.

May attempt a world-wide payout ratio policy to diffuse political tensions. However, may adjust this policy to reflect differences in tax rates on dividend transfers (the local Govt often taxes retained earnings at a much lower rate than earnings paid out as dividends)

See Nestle example on page 450.

REGULATORY SYSTEM ARBITRAGE: Diffuse pressures from price controls, local unions.