Chapter 15
International Corporate Governance and Control
Lecture Outline
International Corporate Governance
Governance by Board Members
Governance by Institutional Investors
Governance by Shareholder Activists
International Corporate Control
Motives for International Acquisitions
Trends in International Acquisitions
Factors Affecting a Target Valuation
Target-Specific Factors
Country-Specific Factors
Example of the Valuation Process
International Screening Process
Estimating the Target’s Value
Changes in Valuation Over Time
Disparity in Foreign Target Valuations
Expected Cash Flows of the Foreign Target
Exchange Rate Effects on Remitted Earnings
Required Return of Acquirer
Other Corporate Control Decisions
International Partial Acquisitions
International Acquisitions of Privatized Businesses
International Divestitures
Control Decisions as Real Options
Call Option on Real Assets
Put Option on Real Assets
International Corporate Governance and Control ❖ 2
Chapter Theme
This chapter emphasizes how an MNC can be subject to governance. The potential for corporate control
can encourage MNC managers to maximize value for their shareholders.
Topics to Stimulate Class Discussion
1. Why are MNCs subject to corporate control?
2. How should MNCs determine whether multinational restructuring is worthwhile?
3. What role does valuation play in the multinational restructuring process?
POINT/COUNTER-POINT:
Can a Foreign Target Be Assessed Like Any Other Asset?
POINT: Yes. The value of a foreign target to an MNC is the present value of the future cash flows to the
MNC. The process of estimating a foreign target’s value is the same as the process of estimating a
machine’s value. A target has expected cash flows, which can be derived from information about previous
cash flows.
COUNTER-POINT: No. A target’s behavior will change after it is acquired by an MNC. Its efficiency
may change depending on the ability of the MNC to integrate the target with its own operations. The
morale of the target employees could either improve or worsen after the acquisition, depending on the
treatment by the acquirer. Thus, a proper estimate of cash flows generated by the target must consider the
changes in the target due to the acquisition.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
Answers to End of Chapter Questions
1. Motives for Restructuring. Why do you think MNCs continuously assess possible forms of
multinational restructuring, such as foreign acquisitions or downsizing of a foreign subsidiary?
2. Exposure to Country Regulations. Maude Inc., a U.S.-based MNC, has recently acquired a firm in
Singapore. To eliminate inefficiencies, Maude downsized the target substantially, eliminating two-
thirds of the workforce. Why might this action affect the regulations imposed on the subsidiary’s
business by the Singapore government?
International Corporate Governance and Control ❖ 3
3. Global Expansion Strategy. Poki Inc., a U.S.-based MNC, is considering expanding into Thailand
because of decreasing profit margins in the U.S. The demand for Poki’s product in Thailand is very
strong. However, forecasts indicate that the baht is expected to depreciate substantially over the next
three years. Should Poki expand into Thailand? What factors may affect its decision?
ANSWER: Poki faces a tradeoff. Demand for its product in Thailand is very strong, while it is
4. Valuation of a Private Target. Rastell, Inc., a U.S.-based MNC, is considering the acquisition of
a Russian target to produce personal computers (PCs) and market them throughout Russia, where
demand for PCs has increased substantially in recent years. Assume that the stock prices of most
Russian companies rose substantially just prior to Rastell’s assessment of the target. If Rastell Inc.
acquires a private target in Russia, will it be able to avoid the impact of the high stock prices on
business valuations in Russia?
5. Comparing International Projects. Savannah, Inc., a manufacturer of clothing, wants to increase its
market share by acquiring a target producing a popular clothing line in Europe. This clothing line is
well established. Forecasts indicate a relatively stable euro over the life of the project. Marquette,
Inc., wants to increase its market share in the personal computer market by acquiring a target in
Thailand that currently produces radios and converting the operations to produce PCs. Forecasts
indicate a depreciation of the baht over the life of the project. Funds resulting from both projects will
be remitted to the respective U.S. parent on a regular basis. Which target do you think will result in a
higher net present value? Why?
ANSWER: The European target will likely result in a higher NPV. First, the euro has generally been
6. Privatized Business Valuations. Why are valuations of privatized businesses previously owned by
the governments of developing countries more difficult than valuations of existing firms in developed
countries?
ANSWER: There are several reasons why the valuation of a privatized business may be more difficult
than the valuation of an existing firm in a developed country. First, future cash flows associated with
7. Valuing a Foreign Target. Blore Inc., a U.S.-based MNC, has screened several targets. Based on
economic and political considerations, only one eligible target remains in Malaysia. Blore would like
you to value this target and has provided you with the following information:
• Blore expects to keep the target for three years, at which time it expects to sell the firm for 300
million Malaysian ringgit (MYR) after any taxes.
• Blore expects a strong Malaysian economy. The estimates for revenue for the next year are
MYR200 million. Revenues are expected to increase by 8% in each of the following two years.
• Cost of goods sold is expected to be 50% of revenue.
• Selling and administrative expenses are expected to be MYR30 million in each of the next three
years.
• The Malaysian tax rate on the target’s earnings is expected to be 35 percent.
• Depreciation expenses are expected to be MYR20 million per year for each of the next three
years.
• The target will need MYR7 million in cash each year to support existing operations.
• The target’s stock price is currently MYR30 per share. The target has 9 million shares
outstanding.
• Any remaining cash flows will be remitted by the target to Blore Inc. Blore uses the prevailing
exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years.
This exchange rate is currently $.25.
• Blore’s required rate of return on similar projects is 20 percent.
a. Prepare a worksheet to estimate the value of the Malaysian target based on the information
provided.
ANSWER:
International Corporate Governance and Control ❖ 5
Valuation of Malaysian Target Based on the Assumptions Provided
(numbers are in millions)
Year 1 Year 2 Year 3
Revenue MYR200 MYR216 MYR233.3
Cost of Goods Sold MYR100 MYR108 MYR116.6
b. Will Blore Inc. be able to acquire the Malaysian target for a price lower than its valuation of
the target?
ANSWER: The Malaysian target’s shares are presently valued at MYR30 per share. Thus, the 9
8. Uncertainty Surrounding a Foreign Target. Refer to question 7. What are some of the key sources
of uncertainty in Blore’s valuation of the target? Identify two reasons why the expected cash flows
from an Asian subsidiary of a U.S.-based MNC would be lower as if Asia experienced a new crisis.
9. Divestiture Strategy. The reduction in expected cash flows of Asian subsidiaries as a result of the
Asian crisis likely resulted in a reduced valuation of these subsidiaries from the parent’s perspective.
Explain why a U.S.-based MNC might not have sold its Asian subsidiaries.
10. Why a Foreign Acquisition May Backfire. Provide two reasons why an MNC’s strategy of
acquiring a foreign target will backfire. That is, explain why the acquisition might result in a negative
NPV.
Advanced Questions
11. Pricing a Foreign Target. Alaska Inc. would like to acquire Estoya Corp., which is located in Peru.
In initial negotiations, Estoya has asked for a purchase price of 1 billion Peruvian new sol. If Alaska
completes the purchase, it would keep Estoya’s operations for two years and then sell the company.
In the recent past, Estoya has generated annual cash flows of 500 million new sol per year, but Alaska
believes that it can increase these cash flows 5 percent each year by improving the operations of the
plant. Given these improvements, Alaska believes it will be able to resell Estoya in two years for 1.2
billion new sol. The current exchange rate of the new sol is $.29, and exchange rate forecasts for the
next two years indicate values of $.29 and $.27, respectively. Given these facts, should Alaska Inc.
pay 1 billion new sol for Estoya Corp. if the required rate of return is 18 percent? What is the
maximum price Alaska should be willing to pay?
International Corporate Governance and Control ❖ 7
ANSWER:
Year 0 1 2
Operating CF 525.00 551.25
12. Global Strategy. Senser Co. established a subsidiary in Russia two years ago. Under its original
plans, Senser intended to operate the subsidiary for a total of four years. However, it would like to
reassess the situation, since exchange rate forecasts for the Russian ruble indicate that it may
depreciate from its current level of $.033 to $.028 next year and to $.025 in the following year. Senser
could sell the subsidiary today for 5 million rubles to a potential acquirer. If Senser continues to
operate the subsidiary, it will generate cash flows of 3 million rubles next year and 4 million rubles in
the following year. These cash flows would be remitted back to the parent in the U.S. The required
rate of return of the project is 16 percent. Should Senser continue operating the Russian subsidiary?
ANSWER:
End of Year 2 End of Year 3 End of Year 4
than the price it could sell the subsidiary for today.
13. Divestiture Decision. Colorado Springs Co. plans to divest either its Singapore or its Canadian
subsidiary. Assume that if exchange rates remain constant, the dollar cash flows each of these
subsidiaries would provide to the parent over time would be somewhat similar. However, the
company expects the Singapore dollar to depreciate against the U.S. dollar, and the Canadian dollar to
appreciate against the U.S. dollar. The firm can sell either subsidiary for about the same price today.
Which one should it sell?
14. Divestiture Decision. San Gabriel Corp. recently considered divesting its Italian subsidiary and
determined that the divestiture was not feasible. The required rate of return on this subsidiary was 17
percent. In the last week, San Gabriel’s required return on that subsidiary increased to 21 percent. If
the sales price of the subsidiary has not changed, explain why the divestiture may now be feasible.
15. Divestiture Decision. Ethridge Co. of Atlanta, Georgia has a subsidiary in India that produces
products and sells them throughout Asia. In response to the September 11, 2001 terrorist attack on the
U.S., Ethridge Co. decided to conduct a capital budgeting analysis to determine whether it should
divest the subsidiary. Why might this decision be different after the attack as opposed to before the
attack? Describe the general method for determining whether the divestiture is financially feasible.
ANSWER: The divestiture decision may be different because cash flow estimates may have changed
16. Feasibility of a Divestiture. Merton Inc. has a subsidiary in Bulgaria that it fully finances with its
own equity. Last week, a firm offered to buy the subsidiary from Merton Inc. for $60 million in cash
and the offer is still available this week as well. The annualized long-term risk-free rate in the U.S.
increased from 7% to 8% this week. The expected monthly cash flows to be generated by the
subsidiary have not changed since last week. The risk premium that Merton Inc. applies to its projects
in Bulgaria was reduced from 11.3% to 10.9% this week. The annualized long-term risk-free rate in
Bulgaria declined from 23% to 21% this week. Would the NPV to Merton Inc. from divesting this
unit be more or less than the NPV determined last week? Why? [No analysis is necessary, but make
sure that your explanation is very clear.]
17. Accounting for Government Restrictions. Sunbelt Inc. plans to purchase a firm in Indonesia. It
believes that it can install its operating procedure in this firm, which would significantly reduce the
firm’s operating expenses. However, the Indonesian government may approve the acquisition only if
Sunbelt does not lay off any workers. How can Sunbelt possibly increase efficiency without laying
off workers? How can Sunbelt account for the Indonesian government’s position as it assesses the
NPV of this possible acquisition?
18. Foreign Acquisition Decision. Florida Co. produces software. Its primary business in Boca
Raton is expected to generate cash flows of $4,000,000 at the end of each of the next 3 years, and
expects that it could sell this business for $10 million (after accounting for capital gains taxes) at the
end of 3 years. Florida Co. also has a side business in Pompano Beach that takes the software created
in Boca Raton and exports it to Europe. As long as the side business distributes this software to
Europe, it is expected to generate $2 million in cash flows at the end of each of the next three years.
This side business in Pompano Beach is separate from Florida’s main business.
Recently, Florida was contacted by a Ryne Co. in Europe which specializes in distributing software
throughout Europe. If Florida acquires Ryne Co., it would rely on Ryne instead of its side business to
sell its software in Europe, because Ryne could easily reach all of Florida Company’s existing
European customers and additional potential European customers. By acquiring Ryne, Florida would
be able to sell much more software in Europe than it can sell with its side business, but it has to
determine whether the acquisition would be feasible. The initial investment to acquire Ryne Co.
would be $7 million. Ryne would generate 6 million euros per year in profits, and would be subject to
a European tax rate of 40%. All after-tax profits would be remitted to Florida Co. at the end of each
year and the profits would not be subject to any U.S taxes since they were already taxed in Europe.
The spot rate of the euro is $1.10 and Florida Co. believes the spot rate is a reasonable forecast of
future exchange rates. Florida Co. expects that it could sell Ryne Co. at the end of 3 years for 3
million euros (after accounting for any capital gains taxes). Florida Company’s required rate of return
on the acquisition is 20%. Determine the net present value of this acquisition. Should Florida Co.
acquire Ryne Co.?
ANSWER:
Year 0
Year 1
Year 2
Year 3
Profit
€6,000,000
€6,000,000
€6,000,000
After tax (40%)
€3,600,000
€3,600,000
€3,600,000
Sale of Company
€3,000,000
Rate
$1.10
$1.10
$1.10
business
business
business
rate)
Initial Investment
19. Foreign Acquisition Decision. Minnesota Company consists of two businesses. Its local business
is expected to generate cash flows of $1,000,000 at the end of each of the next 3 years. It also owns a
foreign subsidiary based in Mexico, whose business is selling technology in Mexico. This business is
expected to generate $2,000,000 in cash flows at the end of each of the next three years. The main
competitor of the Mexican subsidiary is Perez Co., a privately-held firm that is based in Mexico.
Minnesota Company just contacted Perez Co., and wants to acquire it. If it acquires Perez, Minnesota
would merge the operations of Perez Co. with its Mexican subsidiary’s business. It expects that these
merged operations in Mexico would generate a total of $3,000,000 in cash flows at the end of each of
the next 3 years. Perez Co. is willing to be acquired for a price of 40 million pesos. The spot rate of
the Mexican peso is $.10. The required rate of return on this project is 24%. Determine the net present
value of this acquisition by Minnesota Company. Should Minnesota Company pursue this
acquisition?
ANSWER:
Year 1
Year 2
Year 3
Acquiring Perez
Required Rate of Return
Additional Cashflows from
20. Decision to Sell a Business. Kentucky Co. has an existing business in Italy that it is trying to sell.
It receives one offer today from Rome Co. for $20 million (after capital gains taxes are paid).
Alternatively, Venice Co. wants to buy the business, but will not have the funds to make the
acquisition until 2 years from now. It is meeting with Kentucky Co. today to negotiate the acquisition
price that it will pay for Kentucky in two years. If Kentucky Co. retains the business for the next two
years, it expects that the business would generate 6 million euros per year in cash flows (after taxes
are paid) at the end of each of the next two years, which would be remitted to the U.S. The euro is
presently $1.20 and that rate can be used as a forecast of future spot rates. Kentucky would only
retain the business if it can earn a rate of return of at least 18% by keeping the firm for the next two
years rather than selling it to Rome Co. now. Determine the minimum price in dollars at which
Kentucky should be willing to sell its business (after accounting for capital gain taxes paid) to Venice
Co. in order to satisfy its required rate of return.
ANSWER
International Corporate Governance and Control ❖ 11
To determine the minimum price in dollars at which Kentucky Co should be willing to sell the
Year 1
Year 2
Cash flow in euro
€ 6,000,000
€6,000,000
company
21. Foreign Divestiture Decision. Baltimore Co. considers divesting its 6 foreign projects as of
today. Each project will last one year. Its required rate of return on each project is the same. The cost
of operations for each project is denominated in dollars and is the same. Baltimore believes that each
project will generate the equivalent of $10 million in one year based on today’s exchange rate.
However, each project generates its cash flow in a different currency. Baltimore believes that interest
rate parity (IRP) exists. Baltimore forecasts exchange rates as explained in the table below.
a. Based on this information, which project will Baltimore be most likely to divest? Why?
b. Based on this information, which project will Baltimore be least likely to divest? Why?
Project
Comparison of one-year U.S.
and foreign Interest rates
Method used to forecast the
spot rate one year from now
Country A
The U.S. interest rate is higher
than currency A’s interest rate
Spot rate
Country B
The U.S interest rate is higher
than currency B’s interest rate
Forward rate
Country C
The U.S. interest rate is the
same as currency C’s interest
rate
Forward rate
Country D
The U.S. interest rate is the
Spot rate
International Corporate Governance and Control ❖ 12
same as Currency D’s interest
rate
Country E
The U.S. interest rate is lower
than Currency E’s interest rate
Forward rate
Country F
The U.S. interest rate is lower
than Currency F’s interest rate
Spot rate
ANSWER:
22. Factors that Affect the NPV of a Divestiture. Clemson Co. (a U.S. firm) has a subsidiary in
Germany that generates substantial earnings in euros each year. One week ago, it received an offer
from a company to purchase it, and it has not yet responded to this offer.
a. Since last week, the expected stream of euro cash flows has not changed, but the forecasts of the
euro’s value in future periods have been revised downward. Will the NPV of the divestiture be larger
or smaller or the same as it was last week? Briefly explain.
b. Since last week, the expected stream of euro cash flows has not changed, but the long-term interest
rate in the U.S. has declined. Will the NPV of the divestiture be larger or smaller or the same as it was
last week? Briefly explain.
ANSWER:
23. Impact of Country Perspective on Target Valuation. Targ Co. of the U.S. has been targeted by
3 firms that consider acquiring it: (1) Americo (from the U.S.), Japino (of Japan), and Canzo (of
Canada). These 3 firms do not have any other international business, have similar risk levels, and
have a similar capital structure. Each of the 3 potential acquirers has derived similar expected dollar
cash flow estimates for Targ Co. The long-term risk free interest rate is 6% in the U.S.. 9% in
Canada, and 3% in Japan. The stock market conditions are similar in each of the countries. There are
no potential country risk problems that would result from acquiring Targ Co. All potential acquirers
expect that the Canadian dollar will appreciate by 1 percent a year against the U.S. dollar and will be
stable against the Japanese yen. Which firm will likely have the highest valuation of Targ Co.?
Explain.
24. Valuation of a Foreign Target. Gaston Co. (a U.S. firm) is considering the purchase of a target
company based in Mexico. The net cash flows to be generated by this target firm are expected to be
300 million pesos at the end of one year. The existing spot rate of the peso is $.14, while the expected
International Corporate Governance and Control ❖ 13
spot rate in one year is $.12. All cash flows will be remitted to the parent at the end of one year. In
addition, Gaston hopes to sell the company for 800 million pesos (after taxes) at the end of one year.
The target has 10 million shares outstanding. If Gaston purchases this target, it would require a 25
percent return. The maximum value that Gaston should pay for this target company today is ____
pesos per share. Show your work.
ANSWER:
25. Divestiture of a Foreign Subsidiary. Rudecki Co. (a U.S. firm) has a Polish subsidiary that is
considering divesting. This subsidiary is completely focused on research and development for
Rudecki’s other business. Rudecki has cash outflows (paid in zloty, the Polish currency) for the
laboratories and scientists in Poland. Although the subsidiary does not generate any sales, its research
and development lead to new products and higher sales of products that are solely in the U.S. and are
denominated in dollars. There is no foreign competition. Last week, a firm offered to purchase the
subsidiary for $10 million, and the offer is still available. Today Rudecki has revised its forecasts of
the zloty upward for all future periods. Will today’s adjustment in exchange rate forecasts increase,
decrease, or have no effect on the net present value of a divestiture of this subsidiary from Rudecki’s
perspective? Briefly explain. [Keep in mind that the NPV of the divestiture is not the same as the
NPV that results from acquiring a project.]
26. Poison Pills and Takeovers. Explain how a foreign target could use poison pills to prevent a
takeover or change the terms of a takeover.
27. Governance of MNCs by Shareholders. Explain the various ways in which large shareholders
can attempt to govern an MNC and improve its management.
28. Divestiture of a Foreign Subsidiary. Ved Co. (a U.S. firm) has a subsidiary in Germany that
generates substantial earnings in euros each year. It will soon decide whether to divest the subsidiary.
One week ago, a company offered to purchase the subsidiary from Ved Co., and Ved has not yet
responded to this offer.
International Corporate Governance and Control ❖ 14
a. Since last week, the expected stream of euro cash flows has not changed, but the forecasts of the
euro’s value in future periods have been revised downward. When deciding whether a divestiture is
feasible, Ved Co. estimates the NPV of the divestiture. Will Ved’s estimated NPV of the divestiture
be larger or smaller or the same as it was last week? Briefly explain.
b. If the long-term interest rate in the U.S. suddenly declines, and all other factors are unchanged, will
the NPV of the divestiture be larger or smaller or the same as it was last week? Briefly explain.
29. Valuation of a Planned Divestiture. Dallen Co. has a subsidiary in Mexico that does research and
development and produces prescription pills that are transported to and sold in the U.S. The parent
used its own funds to build the subsidiary. Dallen Co. pays for the operations in Mexico in Mexican
pesos, but all of its revenue from selling the pills in the U.S. is in dollars. It has no other international
business. Dallen’s competitors are local firms in the U.S. that have no international operations. Two
days ago, Dallen received an offer from a firm to buy Dallen’s subsidiary, and the offer is in effect for
a few days.
a. Yesterday, an event occurred that makes the parent of Dallen Co. believe that the Mexican peso
will weaken substantially in the future. Do you think the event that occurred yesterday will increase,
decrease, or have no impact on the likelihood that Dallen will accept the offer and sell its subsidiary
at the existing offer price? Briefly explain.
30. Divestiture Decision. Kylee Co. (a U.S. firm) has a British subsidiary that will generate cash flows of
3 million pounds at the end of each of the next two years. It uses the prevailing spot rate of the British
pound of $1.80 as a forecast of the future value of the pound. Its required rate of return on this
business is 16 percent. Kylee just received an offer from a British company who wants to buy the
subsidiary for $8,000,000. Assume that Kylee would not be subject to any tax on the sale.
a. Should Kylee Co. sell the business? Show your work.
ANSWER:
International Corporate Governance and Control ❖ 15
Year 1 Year 2
Expected CF in Pounds 3,000,000 3,000,000
b. Assume that there is news today that causes Kylee to think that the British pound will strengthen
substantially the next two years. Assume the offer price remains unchanged. If Kylee reassesses
whether to divest based on this information, do you think the potential news will increase the net
present value of the divestiture (make the divestiture more beneficial for Kylee), reduce the net
present value of the divestiture, or have no impact on the estimated net present value of the
divestiture? Briefly explain.
c. Assume that today the prevailing long-term U.S. risk-free interest rate decreased, and that this has
no effect on Kylee’s cash flows from operations. Assume the offer price remains unchanged. Do you
think this information about the decline in the U.S. risk-free interest rate will increase the net present
value of the divestiture, reduce the net present value of the divestiture, or have no impact on the
estimated net present value of the divestiture? Briefly explain.
Solution to Continuing Case Problem: Blades, Inc.
1. Using a spreadsheet, determine the NPV of the acquisition of Skates’n’Stuff. Based on your
numerical analysis, should Blades establish a subsidiary in Thailand or acquire Skates’n’Stuff?
2. If Blades negotiates with Skates’n’Stuff, what is the maximum amount (in Thai baht) Blades should
be willing to pay?
3. Are there any other factors Blades should consider in making its decision? In your answer, you should
consider the price Skates’n’Stuff is asking relative to your analysis in question 1, other potential
businesses for sale in Thailand, the source of the information your analysis is based on, the
production process that will be employed by the target in the future, and the future management of
Skates’n’Stuff.
ANSWER: Yes, there are other factors Blades, Inc. should consider in reaching its decision. First,
Blades did not previously consider the acquisition of an existing business in Thailand. There may be
International Corporate Governance and Control ❖ 17
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
1. Units Sold to Retailers in Thailand
2. Price per Unit (in Thai baht)
4,500
5,040
5,645
6,322
7,081
7,931
8,882
9,948
11,142
12,479
13,976
3. Revenue from Sales to Retailers
4. Variable Cost per Unit (in Thai baht)
3,500
3,920
4,390
4,917
5,507
6,168
6,908
7,737
8,666
9,706
10,870
5. Total Variable Cost = (1) × (4) (in 000s)
1,097,600
32,400
6. Less Cost Savings from Production
= (3) – (9) (in baht 000s)
747,521
11. Host Government Tax (25%) (in 000s)
12. After-Tax Earnings of Subsidiary
197,700
199,608
228,961
261,836
298,657
339,895
386,083
437,813
495,750
13. Net Cash Flow to Subsidiary =
17. Salvage Value (000s)
18. Exchange Rate of Thai Baht ($)
19. $ Cash Flow to Parent = (16) × (18)
5,227,702
31,169,086
21. Initial $ Investment by Blades
23,000,000
22. Cumulative PV ($ 000s)
6,642
International Corporate Governance and Control ❖ 18
Solution to Supplemental Case: Redwing Technology Company
a. The earnings performance translated in dollars is misleading because they are distorted by varying
exchange rates. The actual earnings in each local currency in each subsidiary should be assessed,
since the subsidiary has no control over the exchange rate used for translation. The translation causes
earnings to be overstated when the local currency is strong (against the dollar) and understated when
the local currency is weak. The following table shows the earnings of each subsidiary when
Earnings (in millions) Denominated in the Local Currency
Annual Annual Annual
Years Percentage South Percentage Percentage
Ago Canada Increase Africa Increase Japan Increase
5 C$16.80 — R210.00 — Y7,500.00 —
d. The earnings of the Canadian and South African subsidiaries only appear to be highly correlated
International Corporate Governance and Control ❖ 19
Small Business Dilemma
Multinational Restructuring by the Sports Exports Company
1. Are there any reasons why the business that has been so successful in the United Kingdom might not
be successful in other European countries?
2. If the business is diversified throughout Europe, will this substantially reduce the exposure of the
Sports Exports Company to exchange rate risk?
3. Now that several countries in Europe participate in a single currency system, will this affect the
performance of new expansion throughout Europe?