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Title: Wendy Jeffus


1
International Business
  • Wendy Jeffus
  • Harvard Summer School

2
Introduction
  • Team Evaluations Due!
  • Chapter 18 Global Human Resources Management
  • Vineet Garg "HR services Outsourcing by PG to
    IBM"
  • Chapter 19 Accounting in the International
    Business
  • Chapter 20 Financial Management in the
    International Business

3
Chapter 18 Global Human Resources Management
  • Wendy Jeffus
  • Harvard Summer School

4
IBM Thinkpad
  • 2004 Lenovo purchased IBMs PC division for
    1.75B.

Moved global headquarters to New York Acquired
4,000 employees (2,400 in the U.S.) Appointed
Stephen Ward the former head of IBMs PC division
as the CEO of Lenovo
http//www.lenovo.com/planetwide/select/selector.h
tml
5
Human Resource Management
  • Four major tasks of HRM
  • Staffing policy
  • Who do you hire?
  • Management training and development
  • How do you train them?
  • Performance appraisal
  • How do you critique their performance?
  • Compensation policy
  • What should you pay them?

6
HRM
  • Strategic role HRM policies should be congruent
    with the firms strategy and its formal and
    informal structure and controls

Summer 2006 Intern trip to Sea World San Antonio
Source Company websites
7
International HRM
  • Task complicated by profound differences between
    countries
  • Labor Markets
  • Skilled labor, average workday, influence of
    unions,
  • Culture
  • Role of women, role of religion, distance between
    the boss and the employee, emphasis on time!
  • Legal
  • Handshake, legal support, labor laws
  • Economic Systems
  • Fixed vs. floating currencies

8
International Human Resource Mgmt.
HR plays a large role in an organizations
architecture
9
Staffing Policy
  • Staffing policy
  • Selecting individuals with skills to do a
    particular job
  • But also a tool for developing and promoting
    corporate culture
  • 3 types of Staffing Policy

Source Company website
10
1. Ethnocentric Policy
  • Key management positions filled by parent-country
    nationals (belief Home country skills are
    superior)
  • Advantages
  • Overcomes lack of qualified managers in host
    nation
  • Unified culture
  • Helps transfer core competencies
  • Disadvantages
  • Produces resentment in host country
  • Can lead to cultural shortsightedness

11
2. Polycentric Policy
  • Host-country nationals manage subsidiaries
  • Parent company nationals hold key headquarter
    positions (belief each host country is unique)
  • Advantages
  • Alleviates cultural shortsightedness
  • Inexpensive to implement
  • Helps transfer core competencies
  • Disadvantages
  • Limits opportunity to gain experience of host
    country nationals outside their own country
  • Can create gap between home and host country
    operations

12
3. Geocentric Policy
  • Seek best people, regardless of nationality
    (belief there are both similarities and
    differences)
  • Advantages
  • Enables the firm to make best use of its human
    resources
  • Equips executives to work in a number of cultures
  • Helps build strong unifying culture and informal
    management network
  • Disadvantages
  • National immigration policies may limit
    implementation
  • Expensive to implement due to training and
    relocation
  • Compensation structure can be a problem

13
Nestlé Global HRM
  • Headquarters Vevey, Switzerland
  • 250,000 employees, (100 different nationalities)
  • Emphasis on language skills (You must be fluent
    in English and in two other languages)
  • All entry level graduate positions featured are
    international careers.
  • Engineering
  • Nestlé Audit Group
  • Nestlé Productivity Team
  • Marketing Sales
  • Expatriates at Nestlé make a long-term commitment
    to carry out a series of two to three year
    assignments abroad, moving from one country to
    another.
  • International expatriates have the opportunity to
    work in many locations mainly in Asia, Africa,
    Eastern Europe and Latin America.

http//www.nestle.com/Careers/Introduction/Careers
.htm
14
The Expatriate Problem
  • Expatriate citizens of one country working in
    another
  • Expatriate failure premature return of the
    expatriate manager to his/her home country
  • Cost of failure is high estimate 3X the
    expatriates annual salary plus the cost of
    relocation.

15
Reasons for Expatriate Failure
  • US multinationals
  • Inability of spouse to adjust
  • Managers inability to adjust
  • Other family problems
  • Managers personal or emotional immaturity
  • Inability to cope with larger overseas
    responsibilities
  • European multinationals
  • Inability of spouse to adjust
  • Japanese Firms
  • Inability to cope with larger overseas
    responsibilities
  • Difficulties with the new environment
  • Personal or emotional problems
  • Lack of technical competence
  • Inability of spouse to adjust

16
Expatriate Failure Rate
lt
lt
lt
17
Expatriate Selection
  • Reduce expatriate failure rates by improving
    selection procedures
  • An executives domestic performance does not
    (necessarily) equate to his/her overseas
    performance potential
  • Employees need to be selected not solely on
    technical expertise, but also on cross-cultural
    fluency

18
Four Attributes that Predict Success
  • Self-Orientation
  • Possessing high self-esteem, self-confidence and
    mental well-being
  • Others-Orientation
  • Ability to develop relationships with host
    country nationals
  • Willingness to communicate
  • Perceptual Ability
  • The ability to understand why people of other
    countries behave the way they do
  • Being nonjudgmental and flexible in management
    style
  • Cultural Toughness
  • Relationship between country of assignment and
    the expatriates adjustment to it

19
Training
  • Cultural training
  • Seeks to foster an appreciation of the host
    countrys culture
  • Language training
  • Can improve expatriates effectiveness, aids in
    relating more easily to foreign culture, and
    fosters a better firm image
  • Practical training
  • Ease into the day-to-day life of the host country

20
Management Development
  • Development
  • Broader concept involving developing managers
    skills over his or her career with the firm
  • Several foreign postings over a number of years
  • Attend management education programs at regular
    intervals

21
Repatriation of Expatriates
22
Management Development Strategy
  • Development programs designed to increase the
    overall skill levels of managers through
  • Ongoing management education
  • Rotation of managers through a number of jobs
    within the firm to give broad range of
    experiences
  • Used as a strategic tool to build a strong
    unifying culture and informal management network

23
Performance Appraisal
  • Problems
  • Unintentional bias
  • Host nation biased by cultural frame of reference
  • Home country biased by distance and lack of
    experience working abroad
  • Expatriate managers believe that headquarters
    unfairly evaluate and under-appreciate them
  • In a survey of personnel managers in U.S.
    multinationals, 56 stated foreign assignment
    either detrimental or immaterial to ones career

24
Compensation
  • Two issues
  • Pay
  • Should you pay executives in different countries
    according to the standards in each country OR
    equalize pay on a global basis?
  • Method of payment

25
Compensation in Various Countries
Additional source US Bureau of Labor Statistics
http//www.bls.gov/fls/
26
Compensation in Various Countries
27
Expatriate Pay
  • Typically use balance sheet approach
  • Equalizes purchasing power to maintain same
    standard of living across countries
  • Provides financial incentives to offset
    qualitative differences between assignment
    locations

28
Components of Expatriate Pay
  • Base Salary
  • Same range as a similar position in the home
    country
  • Foreign service premium
  • Extra pay for work outside country of origin
  • Allowances
  • Hardship, housing, cost-of-living, and education
    allowances
  • Taxation
  • Firm pays expatriates income tax in the host
    country
  • Benefits
  • Level of medical and pension benefits identical
    overseas

29
The Balance Sheet Approach
30
International Labor Relations
  • Key Issue
  • Degree to which organized labor can limit the
    choices of an international business
  • Aims to foster harmony and minimize conflicts
    between firms and organized labor

31
Concerns of Organized Labor
  • Multinational can counter union bargaining power
    with threats to move production to another
    country
  • Multinational will keep highly skilled tasks in
    its home country and farm out only low-skilled
    tasks to foreign plants
  • Easy to switch locations if economic conditions
    warrant
  • Bargaining power of organized labor is reduced

32
Strategy of Organized Labor
  • Lobby for national legislation to restrict
    multinationals
  • Attempts to achieve international regulations.

33
Chapter 19 Accounting in the International
Business
  • Wendy Jeffus
  • Harvard Summer School

34
Accounting Information Capital Flows
35
Relationship Between Business and Providers of
Capital
  • Three external sources of capital
  • Individual investors
  • Buying shares and bonds
  • Banks
  • Loan capital
  • Government
  • Make loans or investment

Importance of each varies from country to country
36
International Standards
  • Efforts to harmonize accounting standards across
    countries
  • Formation of International Accounting Standards
    Board
  • Members represent 79 countries
  • Responsible for formulating international
    accounting standards (IAS)
  • Has issued over 30 IAS
  • Voluntary compliance
  • Recognition is growing

37
Currency Translation
  • The current rate method
  • Exchange rate at the date on the balance sheet is
    used to translate foreign subsidiary financial
    statements into home country currency
  • Incompatible with historic cost principle where
    the assumption is that the currency is not losing
    value due to inflation.
  • The temporal method
  • The foreign subsidiary assets are translated into
    home-country currency at the time of purchase of
    the asset
  • Changing exchange rates may mean the balance
    sheet may not balance!

Used in Germany, Japan the U.S. If inflation
is high the historic cost principle
underestimates a firms assets, so the
depreciation charges based on these
underestimates can be inadequate for replacing
assets when they wear out or become obsolete.
38
Current Rate Method Example
  • At time 0 a U.S. firm invests 100,000 in a
    Malaysian subsidiary.
  • Exchange Rate at time 0 5MYR/1USD
  • Subsidiary purchases land with 500,000 ringgit.
  • Exchange rate at time 1 4MYR/1USD
  • If this new exchange rate is used to convert the
    value of the land back into dollars, it will seem
    that the land has appreciated by 25!
  • The new value of 500,000 ringgit in dollars is
    125,000!
  • (500,000MYR 4MYR/USD)

39
Temporal Method Example
  • At time 0 a U.S. firm invests 100,000 in a
    Malaysian subsidiary.
  • Exchange Rate at time 0 5MYR/1USD
  • Subsidiary purchases land with 500,000 ringgit.
  • Exchange rate at time 1 4MYR/1USD
  • .

MYR Exchange Rate USD
Cash 500,000 1 5 RM 100,000
Owners equity 500,000 100,000
MYR Exchange Rate USD
Fixed Asset 500,000 1 5 RM 100,000
Translation Gains 25,000
Owners equity 500,000 125,000
40
Current US Practice
  • Statement 52 Foreign Currency Translation
  • Self-sustaining autonomous subsidiary
  • Functional currency is local currency
  • Balance sheet uses exchange rate at
  • end of financial year
  • Income statement is financial year average
  • Integral subsidiary
  • Functional currency is US currency
  • Financial statements use the
  • temporal method
  • Dangling credit or debit increases or
  • Decreases consolidated earnings
  • for the period

Firms using multidomestic or international
strategies.
Firms using global or transnational strategies.
41
Transfer Pricing and Control Systems
  • Transfer prices introduce significant distortions
    into the control process
  • Transfer price must be taken into account when
    setting budgets and evaluating a subsidiarys
    performance

42
Chapter 20 Financial Management in International
Business
  • Wendy Jeffus
  • Harvard Summer School

43
Financial Management
  • Investment Decisions
  • What activities should the company finance?
  • Financing Decisions
  • How should the company finance selected
    activities?
  • Money Management Decisions
  • How can the firm manage its financial resources
    most efficiently?

44
FMC
  • Produces chemicals and farm equipment with
    significant overseas business.
  • 5,000 employees throughout the world (2,600 in
    the US).
  • Segments 1) Agricultural Products, 2) Specialty
    Chemicals and 3) Industrial Chemicals.

59 of 06 Revenue was outside the U.S.
Source 2006 Annual Report, available at
www.fmc.com
45
2007 (Update)
63 of 07 Revenue was outside the U.S.
46
FMCs Competitive Advantage
  • Offers 3-year pricing contracts available in
    multiple currencies.
  • An in-house bank handles 1B in currency
    transactions annually to support these prices.
  • 2006 Annual Report The primary currencies for
    which we have exchange rate exposure are the U.S.
    dollar versus the euro, the euro versus the
    Norwegian krone, the U.S. dollar versus the
    Japanese yen and the U.S. dollar versus the
    Brazilian real.

47
The Finance Function
  • Competitive Advantage through reduced costs of
    value creation and/or adding value by improving
    customer service.
  • Reduce the costs of creating value by
  • Lowering the firms cost of capital
  • Managing foreign exchange risk
  • Minimizing the firms tax burden
  • Reducing exposure to unnecessary risk
  • Managing the cash flows and reserves efficiently

48
Investment Decisions
  • Capital budgeting
  • Quantifies the benefits, costs and risks of an
    investment
  • Managers can reasonably compare different
    investment alternatives within and across
    countries
  • Three issues complicate the process
  • 1. Project and Parent Cash Flows
  • 2. Adjusting for Political Economic Risk
  • 3. Risk Capital Budgeting

49
1. Project and Parent Cash Flows
  • Project cash flows may not reach the parent
  • Host country may block cash-flow repatriation
  • Cash flows may be taxed at an unfavorable rate
  • Host government may require a percentage of cash
    flows to be reinvested in the host country

50
Blocked Funds
  • Blocked Funds When the host countrys
    government prohibits or limits the remittance of
    revenues abroad that are earned by foreign
    corporate investors or by local subsidiaries.
  • Revenue can be in the form of overdue bills,
    royalties and dividends, local earnings, or
    unpaid trade credits.
  • Other forms of revenue Interest payments in
    local currencies servicing hard currency loans,
    licensing fees, advanced payments of import
    duties, and proceeds from the sale of property.
  • Why do governments block funds?
  • To regulate the transfer of FX because of hard
    currency shortages.
  • Methods of blocking funds
  • Restrictions on the percentage of revenues that
    can be repatriated, or making the currency
    inconvertible.
  • Dealing with Blocked Funds - Examples
  • Xerox used its blocked funds to purchase one of
    the largest buildings in Bogota, Colombia
  • Volkswagen invested its earnings to acquire
    ranches in Brazil

Source Haar Jerry, Managing the problem of
blocked funds in Latin America, International
Executive, volume 33, issue 3 p. 7-11.
51
Corporate Tax Rates
http//www.heritage.org/research/features/index/co
untry.cfm?idbenin
52
2. Adjusting for Political Economic Risk
  • Political risk
  • Expropriation
  • Venezuela, 2007
  • Social unrest
  • Economic Collapse
  • Zimbabwe, 2007
  • Economic risk
  • Inflation

53
Recent Coup d'états
  • 2000 Unsuccessful coup in Fiji.
  • 2000 A coup in Ecuador overthrows the president.
  • 2002 Coup attempt against President Hugo Chávez
    in Venezuela, within 48 hours, the elected
    government regained control of the country.
  • 2003 Failed mutiny and coup attempt in the
    Philippines.
  • 2004 Attempted coup in the Democratic Republic
    of Congo .
  • 2004 Failed coup d'état in Chad.
  • 2004 Second attempted coup in the Democratic
    Republic of Congo.
  • 2004 Attempted coup in Equatorial Guinea.
  • 2004 Coup in Haiti.
  • 2005 King Gyanendra of Nepal overthrows the
    government, making him the head of government.
    The government is reestablished April 24, 2006
    after a massive democracy movement.
  • 2006 The Armed Forces of the Philippines
    allegedly attempted a military coup which lead to
    a state of emergency.
  • 2006 The United Front for Democratic Change
    allegedly attempts to instigate a military coup
    in Chad.
  • 2006 The Royal Thai Army orchestrates a coup in
    Thailand that overthrows the Prime Minister while
    he is out of the country.
  • 2006 Attempted military coup in Madagascar.
  • 2006 The military of Fiji overthrows the
    President and Prime Minister in a bloodless coup.
  • 2007 Military coup in Turkey, called 'e-coup'
    (April 27), delivers an ultimatum to the AKP
    government by e-mail.

Source wikipedia.org
54
China KFC
  • KFC was fried by Chinese health inspectors.
  • In China, KFC used a cooking oil preservative,
    that extended the life of frying oil by ten days.
  • The Chinese press claimed that the preservative
    caused cancer.
  • The fact that KFC carefully obeyed regional
    safety standards, and there was no legitimate
    link between this oil preservative and cancer,
    did not matter.

Photo Source www.kfc.com, www.cia.gov
The Economist, March 18, 2004 issue A survey of
business in China.
55
China
  • Product mistrust.
  • Lipton Tea
  • Without any evidence, the Chinese media claimed
    Unilever's Lipton Instant Tea contained
    cancer-causing fluorides.
  • The Chinese Ministry of Agriculture eventually
    admitted the tea was safe after it was finally
    tested.
  • Colgate-Palmolive
  • Colgate-Palmolive's toothpaste was accused of
    containing a carcinogen.
  • All its toothpaste was cleared from shelves in
    Shandong Province.
  • Though, when under official investigation,
    Colgate's toothpaste proven to be harmless by
    Chinese authorities.

Photo Source www.lipton.com www.colgate.com
www.cia.gov
The Economist, March 18, 2004 issue A survey of
business in China.
56
China Procter Gamble
  • Procter Gamble (PG) in China had its SK-II
    beauty products banned for traces of chromium and
    neodymium.
  • Consumers across China dashed to stores for
    refunds (and even refunds on fake SK-II product)
    and literally attacked Procter Gamble's
    Shanghai offices.
  • The chromium-neodymium combination is accepted
    throughout the world the World Health
    Organization allows much higher doses in food!
  • A month later, the Ministry of Health declared
    SK-II products safe.
  • PG lost approximately 80 of its 98 distribution
    outlets.

Photo Source www.pg.com www.cia.gov
The Economist, March 18, 2004 issue A survey of
business in China.
57
China
  • Joint-Ventures
  • PepsiCo
  • America's PepsiCos joint-partner a Sichuan
    bottler, sold the joint-venture to the local
    government in exchange for little goodies such as
    his own car and play money.
  • Subway
  • Subway's Beijing sandwich franchise was robbed by
    their joint-venture partner for nearly quarter of
    a million dollars. Subway only runs 30
    restaurants, after nine years. They predicted
    operating 2,000 by this time.

Photo Source www.pepsi.com www.subway.com
www.cia.gov
The Economist, March 18, 2004 issue A survey of
business in China.
58
China Loral Space
  • Loral Space and Communications spent 185 million
    on ChinaSat 8, a telecommunications satellite
    project.
  • Before the US Government asked them to abandon
    due to US security issues.

Photo Source www.loral.com, www. Cia.gov
The Economist, March 18, 2004 issue A survey of
business in China.
59
India Enron GE
  • The Dabhol Power Project, in 1992, was an Enron
    and General Electric Capital Corp investment.
  • These sponsors starting building this
    2.015-mega-watt plant in Maharashtra, India.
  • The sponsors spent over 1.2B.
  • One of the biggest projects in India's history.
  • When the plant was 23 complete, the newly
    elected government, rejected Phase Two of the
    project because the project had apparently not
    been awarded through competitive bidding, power
    tariffs were too high and it was environmentally
    risky.

Photo Source www.enron.com, www.ge.com,
www.cia.gov
Finnerty, John D., Project Financing
Asset-Based Financial Engineering (Second
Edition) John Wiley Sons, Inc. Hoboken, NY.
60
Georgia AES
  • AES Corporation's 1998 purchase of Telasi,
    Georgia's electricity-distribution company.
  • The venture resulted in one catastrophe that
    could not have been anticipated
  • The murder of AES-Telasi's CFO, Niko Lominadze,
    in 2002.
  • Although the police officer (whose gun was
    identified as the murder weapon) was arrested, he
    was released a few months later.

Photo source www.aes.com www.cia.gov
Source How to Bungle Political Risks A survey
finds that most senior executives consider
overseas perils a low priority, even when they
have investments and operations abroad. Helen
Shaw, CFO.com May 24, 2006
61
Venezuela Telecommunications
  • Feb 2007 The Venezuelan government signed a
    memorandum of understanding to purchase CANTV,
    the countrys largest telecommunications company.
  • the negotiated cost satisfied Verizon and the
    Venezuelan State
  • During 06 Verizon entered into a definitive
    agreement to sell its indirect interest in CANTO
    to Telmex for 677 million
  • after two prior extensions, the parties
    terminated the agreement
  • concluding that regulatory approvals would not be
    granted by the Venezuelan government
  • in Jan 07 the Venezuelan government declared its
    intent to nationalize CANTV at a price of 572
    million

Source Venezuelanalysis.com Venezuelan
Government and Verizon Agree to Telecom
Nationalization Verizon 2006, 10-K, dated Feb.
23, 2007
62
Venezuela Electric Company
  • Feb 2007 Venezuela nationalized EDC,
    Venezuelas largest electric company.
  • AES President Hanrahan stated I think the deal
    is a fair one
  • In connection with the agreement, management
    concluded that a material impairment of the
    investment has occurred Management estimates
    this impairment charge to be in the range of 550
    to 650 million

Source Venezuelanalysis.com Venezuela and
Electric Company Sign Memorandum for
Nationalization
SEC FORM 8-K filed, Feb. 27, 2007
63
Venezuela Oil
  • April 2007 - Major international oil companies,
    agreed Wednesday to grant the Venezuelan
    government majority control over four
    multibillion-dollar heavy-oil projects in the
    vast Orinoco reserve.
  • "We're optimistic that on these conversions of
    the heavy oil projects there's an opportunity for
    the companies to come out OK," said Peter Sommer,
    Chevron's commercial manager for Latin American
    exploration and production.

Source Boston.com Chevron "optimistic" about
Venezuelan takeover
64
Hyperinflation Zimbabwe
  • At a supermarket in Zimbabwe, toilet paper costs
    417 Zimbabwean dollars.
  • Not per roll. 417 is the value of a single
    two-ply sheet.
  • A roll costs 145,750 (US0.69).
  • Toilet paper, bread, margarine, meat, and tea
    have become unimaginable luxuries.
  • The government tripled the salaries of civil
    servants
  • The government admitted that it had printed at
    least 21 trillion in local currency and
    critics say much more to buy the American
    dollars to pay IMF loans.
  • The rise of inflation was caused by a flight of
    foreign capital (after the government seized
    farmland), and a steep increase in the money
    supply - the fall was caused by a rise in
    interest rates and an economic slowdown.

Source New York Times, How Bad Is Inflation in
Zimbabwe? by Michael Wines, May 2, 2006
Available at http//www.nytimes.com/2006/05/02/wo
rld/africa/02 zimbabwe.html?ex1304222400ene4f95
916b4e5d098ei5088
65
Institutional Investors Country Risk Ratings
Latin America
Institutional Investors 1985-2005 Country Credit
Ratings, Institutional Investor, various issues.
66
3. Risk Capital Budgeting
  • Two Methods to account for risky cash flows
  • Change the discount rate
  • Example
  • Use 6 for investments in Great Britain, United
    States, Germany
  • Use 15 for investments in Russia
  • The higher the discount rate, the higher the
    projected net cash flows must be for an
    investment to have a positive NPV.
  • Critics argue 1) it penalizes early cash flows
    too much and 2) does not penalize distant cash
    flows enough.
  • Change the cash flows

67
Formula for NPV
  • Net Present Value (NPV) is the sum of discounted
    expected cash flows.
  • Example expect 10 for 3 years at a 5 discount
    rate.

68
Expected CF
40
100
110
130
160
200
(10)
(50)
(80)
(100)
IRR 20 NPV 0
69
Increase the Discount Rate
40
100
110
130
160
200
(10)
(50)
(80)
(100)
Discount Rate 10 Positive NPV 141
Discount Rate 15 New NPV 30
70
Reduce Future CFs
40
100
110
130
130
130
(10)
(50)
(80)
(100)
Discount Rate 10 New NPV 102
71
  • The goal of financial forecasting is to turn
    chaos into error.
  • Elliott Smith, Boston College

72
Financing Decisions
  • Source of Financing
  • Global Capital Markets
  • Typically have a lower cost of capital
  • Host government-regulations
  • Local debt financing
  • Use local debt financing if the currency is
    expected to depreciate (because if you have
    foreign debt, it will take more of the
    depreciated currency to repay your loans).
  • Financial Structure
  • Debt Equity Ratios
  • Tax laws regarding dividends and interest
  • Norms
  • Average debt ratio in Singapore is 0.34
  • Average debt ratio in Italy is 0.76
  • Average debt ratio in US UK is 0.55

Source Multinational Business Finance, 11th
Edition
73
Lower Interest Rate
  • Domestic
  • If you lend 90 of 100
  • Eurocurrency Market
  • If you lend 100 of 100

at 9.5, you earn 9.50.
Available to Lend (100)
Zero Reserve Requirement
74
Money Management
  • Efficiency Goals
  • Minimize Cash
  • Reduce Transaction Costs
  • Tax Considerations
  • Tax credits, tax treaties, etc.
  • Dividend Remittances
  • Royalty Payments Fees
  • Transfer Prices

75
3 Foreign Exchange Risks
  • Transaction exposure
  • The extent to which income from individual
    transactions is affected by fluctuations in
    foreign exchange values.
  • Translation exposure
  • The extent to which the reported consolidated
    results and balance sheets of a corporation are
    affected by fluctuations in foreign exchange
    values.
  • Economic exposure
  • The extent to which a firms international
    earning power is affected by changes in interest
    rates.

76
Tax Treaties Japan/Germany/U.S.
77
International Offshore Financial Centers
78
Transfer Pricing
  • Today a product may be designed in one country,
    some of the components manufactured in another
    country, other components manufactured in a third
    country, all assembled in a fourth country, and
    sold worldwide.
  • The volume of intrafirm transactions is high.

79
Transfer Pricing Example
Price paid to German SBU 23 Sale price
25 Profit 2
Example A U.S. parent company sells Stuffed
Bears. Parts are made at an Australian
subsidiary, assembled in a German subsidiary and
sold in the U.S.
U.S. Parent Company
Ships Product
German subsidiary
Component Source Australian subsidiary
Ships Parts
Price paid to Australian SBU 10 Additional Cost
to Produce 10 Sale price 23 Profit 3
Cost to produce 8 Sale Price 10 Profit 2
80
Transfer Pricing Example
Price paid to German SBU 23 Sale price
25 Profit 2
Example A U.S. parent company sells Stuffed
Bears. Parts are made at an Australian
subsidiary, assembled in a German subsidiary and
sold in the U.S.
U.S. Parent Company
Tax Rate 35 Profit 1.30
Ships Product
Total Profit After Tax 4.40
German subsidiary
Component Source Australian subsidiary
Ships Parts
Price paid to Australian SBU 10 Additional Cost
to Produce 10 Sale price 23 Profit 3
Cost to produce 8 Sale Price 10 Profit 2
Tax Rate 35 Profit 1.30
Tax Rate 40 Profit 1.80
81
Transfer Pricing Example
Price paid to German SBU 23 Sale price
25 Profit 2
Example A U.S. parent company sells Stuffed
Bears. Parts are made at an Australian
subsidiary, assembled in a German subsidiary and
sold in the U.S.
U.S. Parent Company
Tax Rate 35 Profit 1.30
Ships Product
Total Profit After Tax 4.50
German subsidiary
Component Source Australian subsidiary
Ships Parts
Price paid to Australian SBU 12 Additional Cost
to Produce 10 Sale price 23 Profit 1
Cost to produce 8 Sale Price 12 Profit 4
Tax Rate 35 Profit 2.60
Tax Rate 40 Profit 0.60
82
Manipulating Transfer Prices
  • Pros
  • Minimizes tax liabilities
  • Hedges against foreign exchange risk
  • Circumvents government restrictions on capital
    flows
  • Reduce tariff payments
  • Cons
  • Distorts incentive systems
  • Ethical considerations
  • Regulation Scrutiny!

83
  • International finance is the art of passing
    currency from hand to hand until it disappears
  • Anonymous Author

84
Tomorrow
  • The Bottom Line
  • So Why is Harvard Great?
  • Final Exam Review
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