CHAPTER 14
FUNDING THE MULTINATIONAL FIRM
1. Sourcing Global Debt and Equity Markets. What is the sequence of strategies used to
source both equity and debt capital globally? Should a firm start by sourcing global debt or
equity markets?
Before designing a strategy to help a firm gain access to global capital and debt markets, an
investment bank should first be selected as an official advisor to the firm to navigate the
potential investors and numerous institutional requirements. Then, in order to gradually
attract foreign investors, firms should start with an international bond issue on the domestic
market, followed by an illiquid market. Then, it can move to issuing equity and cross-listing
stocks in less liquid markets to attract the attention of global investors and then cross-list
2. Optimal Financial Structure. If the cost of debt is less than the cost of equity, why doesn’t
the firm’s cost of capital continue to decrease with the use of more and more debt?
When taxes and bankruptcy costs are considered, a firm has an optimal financial structure
determined by that particular mix of debt and equity that minimizes the firm’s cost of capital
3. Multinationals and Cash Flow Diversification. How does the multinational’s ability to
diversify its cash flows alter its ability to use greater amounts of debt?
Multinational firms are in a better position than domestic firms to support higher debt ratios
because their cash flows are diversified internationally. The probability of a firm’s covering
4. Foreign Currency Debt. What are the costs and benefits of taking loans in foreign
currency?
Firms may hedge long-term foreign currency risk by taking debt in the same foreign
currency. The main advantage of this type of hedging is longer term, through reduced
5. Three Keys to Global Equity. What are the three key elements related to raising equity
capital in the global marketplace?
Equity issuance, equity listing, and private placement.
6. Global Equity Alternatives. What are the alternative structures available for raising equity
capital on the global market?
1. Sale of a directed public share issue to investors in a target market.
7. Directed Public Issues. What is a directed public issue? What is the purpose of this kind of
an international equity issuance?
A directed public share issue is defined as one that is targeted at investors in a single country
and underwritten in whole or in part by investment institutions from that country. The issue
8. Depositary Receipts. What is a depositary receipt? What are equity shares listed and issued
in foreign equity markets in this form?
Depositary receipts (depositary shares) are negotiable certificates issued by a bank to
9. GDRs, ADRs and GRSs. What is the difference between a GDR, ADR, and GRS? How are
these differences significant?
Similar to ordinary shares, GDRs have the added benefit of being able to be traded on equity
exchanges around the globe in a variety of currencies. ADRs, however, are quoted only in
U.S. dollars and are traded only in the United States. GDRs can, theoretically, be traded with
10. Sponsored and Unsponsored. ADRs and GDRs can be sponsored or unsponsored. What
does it mean and will it matter to the investors purchasing the shares?
Sponsored depositary receipts. Sponsored ADRs are created at the request of a foreign firm
wanting its shares traded in the United States. The firm applies to the Securities and
Exchange Commission (SEC) and a U.S. bank for registration and issuance of ADRs.
11. Depository Receipts (DRS). What are the benefits of DRs to issuers and investors? What are
the risks associated with delisting DRs?
DRs help firms access foreign stock markets without going through the lengthy and costly
listing process. Investors prefer these certificates since it gives them access to securities of
emerging countries’ firms without going through the problems of foreign exchange risk
exposure. However, a number of problems can arise when delisting DRs. If investors choose
to hold the underlying foreign stock at the time that the issuer terminates the DR, then the
12. IPOs and FOs. What is the significance of IPOs versus FOs?
An IPO, an initial public offering, is when a firm first raises capital by listing its shares in a
public market. The FO or follow-on offerings is when the company over time issues
additional shares in the public market in order to raise additional equity.
13. Cross-Listing. What are the main benefits and disadvantages to firms that cross-list their
shares on multiple stock markets?
Cross listing is when a firm lists its shares on one or more foreign stock exchanges in
addition to its primary listing on the domestic stock exchange. The main advantages of
secondary listing (issuing on stock exchanges other than the primary listing) are to access
new markets with increased amounts of capital and to benefit from the possible lower cost of
capital on these markets. A second important advantage of cross-listings on deeper and more
14. GDR and Domestic Share Prices. Should there be a strong co-movement of GDR price
with that of the underlying domestic share? Explain.
In order to enable individual and institutional investors to diversify their portfolios and
reduce risks as well as to enable firms to tap investment funds, both demand and supply of
GDRs have grown in recent years. Since the function of GDRs is to spare investors from the
underlying risks on domestic markets, one would assume that the domestic and GDR prices
15. Barriers to Cross-Listing. What are the main barriers to cross-listing abroad?
A decision to cross-list must be balanced against the implied increased commitment to full
disclosure and a continuing investor relations program. For firms resident in the Anglo-
American markets, listing abroad might not appear to be much of a barrier. For example, the
SEC’s disclosure rules for listing in the United States are so stringent and costly that any
16. Private Placement. What is a private placement? What are the comparative pros and cons of
private placement versus a pubic issue?
A firm, public or private, can place an issue with private investors, a private placement.
17. MNE Exit Strategy. Suppose an MNE plans on operating temporarily in a new market.
Should it cooperate with a local venture capital or a private equity firm?
If an MNE plans on operating temporarily in a new market, it needs to plan its exit strategy.
While venture capital (VC) funds invest in start-ups seeking solid geometric growth, private
equity (PE) firms typically bet on investing in profitable companies that are neither very
18. Bank Loans Versus Securitized Debt. What is the advantage of securitized debt
instruments sold on a market versus bank borrowing for multinational corporations?
If a multinational firm is widely known in the global capital markets, it generally prefers to
issue securitized debt over the use of bank loans. Purchasers of eurobonds do not rely only on
bond-rating services or on detailed analyses of financial statements. The general reputation of
19. International Debt Instruments. What are the primary alternative instruments available for
raising debt on the international marketplace?
Syndicated loans. Syndication allows many different investors to “participate” in the
funding of the loan, thereby allowing them to diversify their risk or exposure to the
individual borrower. The result is the borrower gains access to a greater availability of capital
at a lower cost of funds.
establishment of liquid secondary markets. The banks received substantial fees initially for
their underwriting and placement services.
Euro-medium term notes. The EMTN’s basic characteristics are similar to those of a bond,
with principal, maturity, and coupon structures and rates being comparable. The EMTN’s
typical maturities range from as little as nine months to a maximum of 10 years. Coupons are
typically paid semiannually, and coupon rates are comparable to similar bond issues. The
EMTN does, however, have three unique characteristics. First, the EMTN is a facility,
allowing continuous issuance over a period of time, unlike a bond issue which is essentially
sold all at once. Second, because EMTNs are sold continuously, in order to make debt
service (coupon redemption) manageable, coupons are paid on set calendar dates regardless
of the date of issuance. Finally, EMTNs are issued in relatively small denominations, from
$2 million to $5 million, making medium-term debt acquisition much more flexible than the
20. Eurobond versus Foreign Bonds. What is the difference between a eurobond and a foreign
bond and why do two types of international bonds exist?
All international bonds fall within two generic classifications, Eurobonds and foreign bonds.
The distinction between categories is based on whether the borrower is a domestic or a
foreign resident, and whether the issue is denominated in the local currency or a foreign
currency.
▪ A foreign bond is underwritten by a syndicate composed of members from a single
country, sold principally within that country, and denominated in the currency of that
country. The issuer, however, is from another country. A bond issued by a firm resident
in Sweden, denominated in dollars, and sold in the U.S. to U.S. investors by U.S.
investment bankers, would be a foreign bond. Foreign bonds have nicknames: foreign
bonds sold in the U.S. are “Yankee bonds”; foreign bonds sold in the United Kingdom
are “bulldogs.”
21. Funding Foreign Subsidiaries. What are the primary methods of funding foreign
subsidiaries, and how do host government concerns affect those choices?
In general, although a minimum amount of equity capital from the parent company is
required, multinationals often strive to minimize the amount of equity in foreign subsidiaries
in order to limit risks of losing that capital. Equity investment can take the form of either
cash or real goods (machinery, equipment, inventory, etc.).
22. Local Norms. Should foreign subsidiaries of multinational firms conform to the capital
structure norms of the host country or to the norms of their parent’s country?
Main advantages of localization. The main advantages of a finance structure for foreign
subsidiaries that conforms to local debt norms are as follows:
▪ A localized financial structure reduces criticism of foreign subsidiaries that have been
operating with too high a proportion of debt (judged by local standards), often resulting in
▪ In economies where interest rates are relatively high because of a scarcity of capital, and
real resources are fully utilized (full employment), the penalty paid for borrowing local
Main disadvantages of localization. The main disadvantages of localized financial
structures are as follows:
▪ An MNE is expected to have a comparative advantage over local firms in overcoming
imperfections in national capital markets through better availability of capital and the
ability to diversify risk. Why should it throw away these important competitive
advantages to conform to local norms established in response to imperfect local capital
markets, historical precedent, and institutional constraints that do not apply to the MNE?
1. The consolidated debt ratio is pushed completely out of the discretionary range of
acceptable debt ratios in the flat area of the cost of capital curve, shown previously in
Exhibit 16.1.
2. The MNE is unable to offset high debt in one foreign subsidiary with low debt in
other foreign or domestic subsidiaries at the same cost. If the International Fisher
effect is working, replacement of debt should be possible at an equal after-tax cost
after adjusting for foreign exchange risk. On the other hand, if market imperfections
preclude this type of replacement, the possibility exists that the overall cost of debt,
and thus the cost of capital, could increase if the MNE attempts to conform to local
norms.
23. Internal and External Financing of Foreign Subsidiaries. Explain if it is advisable for
MNEs to seek internal or external sources of finance for their subsidiaries.
When seeking sources of finance, MNEs and their subsidiaries choose between internal and
external sources of finance. The best choice is the one that is cheapest. When choosing
external sources of funding, the main criterion should be to minimize the cost of funds after
24. Credit Terms. Why do MNEs with high credit rating get better credit terms in comparison to
their smaller counterparts?
Before issuing securities on stock markets, MNEs would generally approach credit rating
firms to assess and provide credit rating. When the credit rating is in line with what the