ACME is a US-based MNE that wishes to raise for its Greenfield investments and wishes to secure all funds in the US. Long-term funding is required by ACME, as the project costs around $500m. As we know multinational enterprises are domiciled in various countries and that causes the capital structure of such companies to be different from domestic companies. That are many factors that influence the capital structure of multinational enterprises such as international capital markets, international diversification of MNEs, factors that are unique to the host country of such multinational enterprises, and many others factors.
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The advantage of the International capital market to multinationals is that they have access to international bond and equity markets like Euromarkets. This access to raising funds on an international level provides the benefits of lower long-term financing costs, as compared to domestic companies. Moreover, MNEs have access to currencies of different countries as they have establishments in a number of countries.
This access to different currencies causes variance effects in the capital structure of MNEs as different currencies have different values when converted into reporting currency. Such accessibility also creates a sort of disadvantage whereby the administrative costs of raising funds go up, particularly the agency costs. This may be due to imperfection in foreign markets, political risk factors, and other complexities in the international financial environments.
MNEs can also take the advantage of international diversification by raising funds from different countries. In a way, they get to reduce the risks in raising cash flows because of diversifying effects of international presence. That is why debt ratios of different MNEs have never been standardized. Some are low geared when they raise excessive equity funds for financing their assets. On the other hand, most of MNEs are highly geared because of their easy accessibility to world debt markets like Eurobonds, which are ‘long term loan issued in a currency other than that of the country or market in which it is issued. Interest is paid without the deduction of tax.’(Channel- Forex)1
The host country of multinationals sometimes plays a decisive role in structuring the capital for multinationals. There may be legal or tax tangles, or other political, social, or financial compulsions that force multinationals to consider a different alternative for capital structuring than originally planned. Ultimately multinationals have to consider both global and domestic factors before finally formulating a suitable capital structure for the company.
Though multinationals have access to a variety of sources, the most widely used avenue of raising funds by multinationals is the issuance of International Bonds ‘that is issued in a country by non-domestic entity’2. The importance of international bonds is that it is initially sold in countries outside the country of its issuance. It is often distributed in a number of countries. These are Foreign Bonds when sold in the country in which its issue is denominated.
Further, such international bonds are called Eurobonds when mostly sold in countries other than the country in which the issue is denominated. Eurobonds are favored over foreign bonds, mainly because the US dollar and Euro are favored currencies in world financial markets and the majority of international transactions take place in these currencies.
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Then there are equity-linked Eurobonds. ‘Although Eurobond market has been reasonably well developed for almost two decades, only recently there has been a proliferation of equity-linked Eurobonds, as issuers have attempted to respond to historically high Eurobonds interest rates and the opportunities to reduce the nominal yield of issues by providing for the conversion of the bond or by attaching warrants for the purchase of the stock of the issuer.'(William R. Folks, Jr. Michael g. Ferri)3
The important point to note from the point of ACME is that in the case of ‘foreign bonds’, the interest rates will be correlated with US domestic rates. This has the influence of local conditions over the interest rates and thus some time biased and disconnected from the international financial arena. However, in the case of Euro bonds, several interest rates become influential. For example, in case Euro bonds are issued in the dollar, then different rates like US long term rates, the Eurodollar rate, and long term rates of other countries influence the interest rates of such bonds.
Multinationals like ACME, which is incorporated in the US, can also raise equity capital abroad. Such issues can be brought in by selling the shares in international capital markets; or through the medium of joint ventures in different countries. For the first alternative, ACME has to enlist itself in different stock exchanges of the world. But at each stock exchange, the basic dominance is of domestic companies. However, when there are uniform rules and regulations that are unbiased towards domestic companies, then companies like ACME and other MNEs can take full advantage of such a scenario. Unfortunately, such markets do not exist on the international scene.
Joint ventures with domestic companies are safe to raise equity capital for ACME, but local laws many a time put strict restrictions favoring the domestic scene. There may be restrictions like MNEs to maintain less than 50% ownership in their joint ventures with locally incorporated subsidiaries and like that.
Considering all pros and cons of debts and equity funds, the issuance of Eurobonds by ACME will bring in more stability and relevance to funds to be raised for Greenfield investments of ACME. ACME may also wish to use a combination of equity and debts if it decides to raise equity through a joint venture. But when funds are raised from the host country, that is the US, then ACME should raise as little equity and as many debts from the US. This is so as the use of debt from the host country will be a good protective measure that will lessen the potential impacts of political risks and other factors.
- Channel- Forex, Eurobonds defined, Forex Glossary. 2008. Web.
- Investopedia, International Bonds. 2008. Web.
- William R. Folks, Jr. Michael g. Ferri, Equity- Linked Crossed- Currency International Financial Instruments: A study of pricing of Euro- Warrants, Managerial Finance, Volume 13, Issue 1, Page 23-26.