Identify common political factors for an MNC to consider when assessing country risk. Briefly elaborate on how each factor can affect the risk to the MNC
Extension of business operations into the cross-border market always gives new opportunities to the MNC managers. Nevertheless, the extension also brings new risks and costs. Country risks usually include the political and financial aspects. “Political risks arise because of unexpected changes in the political environment within the host country or in the relationship of a host country to other countries” (Butler, 2012). The unforeseen events and the shifts in the country’s economic situation constitute the financial risks (Alon & Herbert, 2009). Several types of political risks exist, and their number varies according to the different scholars’ research. Two main types that are determined by most financial scholars are operational restrictions and expropriation. When the host country implements the operational restrictions, it means that the MNC’s freedom of functioning is limited. The operational restrictions affect “employment policies; locally shared ownership; loss of transfer freedom; exchange controls; financial, personal, or ownership rights; breaches of unilateral revisions in contracts and agreements; discrimination through taxes or compulsory joint ventures; and damage to property or personnel from riots, revolutions, and wars” (Kim & Kim, 2009). Expropriation means the compulsory sale or confiscation of the company’s assets to the local businesses and government.
The country’s risk can negatively affect the company’s value “through changes in expected future cash flows or changes in investor’s required returns” (Butler, 2012). Thus, the managers need to understand that the MNC’s operations in foreign countries are highly dependent on their political policies and regimes. MNC is bound to be subject to these policies. The political changes influence the company to a large extent. Thus, the forecasting of the risks and the preliminary evaluations must be included in the MNC business strategies.
Explain how the characteristics of MNCs can affect the cost of capital
The cost of capital is “investors’ required return on long-term debt and equity capital” that is significantly dependent on the MNC’s capital structure and financial policies (Butler, 2012). The average cost of capital consists of the cost of debt, the cost of equity, and the cost of preferred stock; and while the company evaluates its projects the cost of capital is always taken into account. A company can obtain the funds from another domestic “parent company” or a “foreign subsidiary” (Kim & Kim, 2009). Nevertheless, MNCs often use a combination of these two. The taxes, inflation, exchange rates, the prices increase or decrease are determined by the domestic or foreign perspectives. Each of them has potential risks and advantages in the political and financial areas.
The purely domestic companies usually have a high cost of capital. At the same time, while borrowing money MNCs can enjoy the lower rates of interest because they are big. They also have the opportunity to raise funds in multiple international markets (Cullen & Parboteeah, 2013). MNCs can decrease the tax rates by using “tax-haven countries, tax-saving holding companies, and transfer pricing” (Kim & Kim, 2009). Moreover, MNCs have a bigger amount of investment opportunities because the domestic markets are usually oversaturated. Thus, domestic companies face more risks. The diversified structure of the MNCs also has an impact on the cost of capital.
Alon, I., & Herbert, T. (2009). A stranger in a strange land: Micro political risk and the multinational firm. Business Horizons, 52(2), 127-137.
Butler, K. (2012). Multinational Finance: Evaluating opportunities, costs, and risks of operations. New York, NY: Wiley Finance.
Cullen, J., & Parboteeah, K. (2013). Multinational management: A strategic approach. Boston, MA: Cengage Learning.
Kim, S., & Kim, S. (2009). Global corporate finance: Text and cases. Oxford, UK: Blackwell Publishing.