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International Business Financial and Trade Essay

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Updated: Jun 6th, 2019

Goals and Forms of Corporate Governance in Global Marketplace

Several new forms of corporate governance have surfaced in the last decade partly due to the failures and weakness of traditional forms of regulations (Drezner 2000, p. 64). The novel forms of corporate governance consist of what can be termed as social regulation of the market in which advocacy groups collaborate with the private sector to regulate activities of corporate organizations.

This collaboration usually entails developing systems and codes of conducts for monitoring and compliance, codes for public disclosure as well as using certification systems to generate market enticements for precise forms of conduct (Haufler 2003).

Forms of Corporate Governance

Some scholars have asserted that the emergence of economic globalization has gradually weakened conventional regulatory systems (enforced by national governments) in order to attract foreign investments (Egan 2001). As a result, co-regulation has thus emerged as the standard practice in which both the government as well as the private sector collaborate in the processes of regulation.

Under this system, the market actors are assigned the role of crafting codes of practice while the government applies sanctions for non-compliance. For example, the US Environmental Protection Agency has implemented a co-regulation system on a trial basis (Egan 2001).

Industry self-regulation is another form of corporate governance in which the private sector designs best practices and technical standards for its use. Self-regulation is particularly prevalent with regard to the development of codes for technical innovations (Spar 2001).

In essence, industry self-regulation entails a close collaboration among firms in developing their own codes of conduct. Unlike the traditional regulation, this system is grounded upon voluntary actions and standards (Haufler 2003).

Although industry self-regulation system is not new with respect to technical product standards, corporate firms have transcended this system in the recent years by controlling their actions on the environmental and the manner in which they manufacture and market their products.

For instance, the 1990s saw a significant rise in the number of new forms of corporate codes of conduct whereby corporate organizations (acting on their own or via trade associations) strived to protect environment, sustain fine labour standards as well as behave as excellent corporate citizens (Haufler 2001).

Multi-stakeholder regulation is another form of corporate regulation employed by firms. This regulatory framework has been developed (on the basis of several global policy issues) by a number of different actors from non-profit communities, private sectors and the public. Some examples of multi-stakeholder regulation include: Forest Stewardship Council; Global Reporting Initiative; and the World Commission on Dams.

These initiatives normally entail a set of goals and/or standards, a decision-making framework as well as a procedure for accomplishing the standards. In many instances, certification systems are developed for these programmes in order to create market inducements for compliance.

These systems are ultimately enforced by consumers while autonomous certifiers provide information about corporate conduct. It is worthy to mention that a multi-stakeholder regulatory framework typically includes a variety of forms (Haufler 2003).

For example, a multi-stakeholder regulatory framework can be as simple as the corporate code of conduct developed by Amnesty International on human rights issues or a comprehensive one such as the Global Reporting Initiative; an international program that develops uniform standards for public disclosure on environmental behaviours of corporate organizations.

It is worth to note that both multi-stakeholder regulation and industry self regulation are preferred by many corporate organizations because of their voluntary nature. What’s more, their respective certification systems have a somewhat soft enforcement via market inducements.

Since there are numerous certification systems in place, corporate firms usually opt for the most effective but least costly certification systems that will guarantee them support from consumers as well as augment their competitive advantages in the global market (Haufler 2003).

The Pros and Cons of Hedging Foreign Exchange Transaction

According to Wong (2000), corporate organizations as well as global investors use forward markets to hedge their foreign exchange exposures (p.387). What’s more, any prediction regarding the future value of a currency is an auxiliary outcome of the hedging activity in the forward market (Roubini 2001).

Multinational corporations that have uneven cash flows in diverse foreign currencies usually strive to protect their investments from unanticipated fluctuations in foreign exchange rates.

Although other alternatives of hedging exist, forward foreign exchange market offers a somewhat easy and standard means for hedging foreign exchange risk. Under the forward foreign exchange, a multinational firm can procure as well as sell foreign currencies at the current rate for future delivery (Higgins & Humpage 2005).

Nevertheless, a number of emerging economies such as Taiwan, Indonesia, Malaysia, India as well as China usually limit foreign access to on-shore money markets and their local currencies thereby severely reducing the ability of international investors or foreign firms to hedge in local forward markets.

The main justification for imposing these curbs is that monetary authorities in emerging economies fear that unrestricted foreign access to on-shore domestic deposits and currency loans as well as the ability to easily move domestic currencies by foreign investors can spur speculative financial fluctuations, increase volatility in exchange rate and eventually result in the loss of monetary control (Higgins & Humpage 2005).

In contrast to the normal forward transaction in which foreign currency delivery actually occurs, nondeliverable forward (NDF) transactions are usually carried out using a convertible currency (U.S dollar) and not in an emerging market currency.

Products such as corn and wheat are usually traded in structured future markets which offer protection to commodity dealers. Normally, parties to a future contract do not accept delivery in the underlying commodity. Rather, positions are agreed upon in dollars (Higgins & Humpage 2005).

Nevertheless, NDF constitutes a zero-sum game in which one party gains at the expense of another party. This means that both parties have an inducement to increase their potential gain (and the other’s loss) by making the exchange rate (of the contract) equivalent to the anticipated future spot exchange rate.

Thus, market participants, such as large banks, hedge funds, portfolio investors and multinational corporations typically employ all accessible information to formulate their expectations.

In case the NDF market is characterized by numerous buyers and sellers with unlimited access to funding and relevant information, the principle of large numbers should justify that NDF exchange rate excerpts are precise estimates of future spot exchange rates with negligible errors that are evenly distributed around zero (Higgins & Humpage 2005).

Multinational corporations are not only exceptional with respect to information processing but also are extremely careful and seek reimbursement for investing in riskier projects. For example, foreign firms that invest in volatile markets incorporate risk premiums in their forward quotes thereby causing the forward exchange rate to stray from the anticipated future spot value of the currency.

These premiums vary with changes in economic situations as well as the changing profitability of risk. Although NDF contracts are executed in dollars, the principal spot exchange rate (against whose fluctuations NDF participants compute payoffs) is usually determined by official interventions, government restrictions as well as large discrete variations that affect the market risk (Higgins & Humpage 2005).

Available Alternatives to a Firm to Manage a Large Transaction Exposure

NDFs are the best option for multinational corporations to hedge their exchange rate exposure in circumstance where local regimes restrict foreign access to on-shore money markets (Ahn & Robert 1998, p. 359; Hentschel & Kothari 2001, p. 93).

Although the exchange rates quoted on NDFs may precisely mirror the market’s estimation regarding the future direction of the exchange rate, discrete adjustments in emerging markets make NDFs somewhat inaccurate with regard to the volume of the change as well as timing (Higgins & Humpage 2005).

Issues in Working Capital Management for Multinational Operations

HDG is an international firm that produces durable goods for government, business and consumers in over 50 countries. According to Brown (2001), one of the core objectives of HDG is to “make it easier for customers to do business with HDG” as well as “reduce their costs” (p.402).

Foreign Exchange Risk Management

Given its global operation, HDG employs forward contracts as well as foreign currency purchased option contracts to minimize its exposure to fluctuation in foreign currency.

In addition, HDG has adopted a forex risk-management policy in order to curb the sizes, types as well as timing of derivative positions. This policy also stipulates the specific procedures that must be adopted by all employees engaged in forex transactions (Brown 2001, p.403).

One of the core features of HDG’s foreign exchange policy relates to the nature of exposures as well as the precise criteria for hedging them. HDG has identified three forms of foreign currency exposures:

  1. Transaction exposure- exposure emerging from carrying out transactions using different foreign currencies apart from the functional currency of each legal unit.
  2. Translation exposure- one that emerges as a result of translating foreign currency financial statements into U.S dollars.
  3. Economic exposure- exposure as a result of expected foreign currency flows which are presently not included in accounting systems (Brown 2001, p.404).

HDG usually hedges its transaction exposures mechanically. As economic exposures turn into transaction exposures, the firm employs spot or forward transactions to hedge the expected cash flow in foreign currency. It is worthy to note that what HDG perceives an economic exposure would be deemed by other firms as a normal transaction exposure.

Economic exposure typically entails cash flow risks that emerge from strategic concerns, competitive forces as well as macroeconomic shocks. In essence, the cash flows to be hedged by HDG are the outcome of expected but not strictly committed sales (Brown 2001, p.406; Graham & Rogers 2002, p.815).

To be precise, the economic exposures facing HDG are mainly attributed to four sources: expected sales from the firm’s manufacturing plants (subject to the business plan of HDG); expected procurement in foreign currencies on the basis of HDG’s purchasing plan; expected operating costs in the foreign currencies according to the firm’s expense plan; and expected third-party sales in foreign currencies (subject to HDG’s sales plan).

It is worthy to mention that the economic exposures facing HDG are based upon the accounting description of transaction as well as the broad description of economic on the basis of several aspects including the nature of the product market, hedge time horizon and the degree of uncertainty in exposure estimates (Brown 2001, p.407; Core & Guay 2002, p. 613).

The procedure used to implement a hedge is somewhat intricate. The procedure begins with the forex group which provides a hedge rate indicator. This indicator is then employed by foreign firms to develop a business plan. The plan is then conveyed to Tax Accounting department which establishes the official forex exposure.

At this stage, a hedging strategy is developed by the forex group on the basis of the market outlook (which depicts the pricing of related derivatives as well as the current exchange rate level). The forex group uses internal technical analysis, external market forecasts as well as forward contracts to assess alternative hedging strategies.

The forex group then deliberates with regional Treasury Managers, the Director of Global Treasury and the Manager of Foreign Exchange to compare different alternatives and then proposes the optimal hedging strategy to the Foreign Exchange Management Committee (FXMC) for approval (Brown 2001, p.409).

What’s more, foreign currencies exposures are not amassed across regions, currencies or quarters. Instead, the foreign currency for each quarter is managed separately. For instance, at any point in time, HDG has five distinct hedges for the German Mark: one hedge for the current quarter and one for every subsequent quarter. As such, each (currency) quarter has a distinct hedge rate.

The latter is computed on the basis of the present market rates as well as the cost of derivatives utilized to hedge the current quarter. For instance, suppose the present forward rate for German Marks is 1.6517 and the spot rate is 71%.

If the exposure is currently hedged at 71% with an existing hedge rate of 1.6258 and the cost of the option needed to raise the hedge to 100% is 0.022, then the hedge rate will be 1.6397 or 0.29% [0.220+ 1.6517] + 0.71[1.6397]. Nevertheless, this method of computing the hedge rate prejudices the result toward lower expected dollar revenues (Brown 2001, p.412).

In nutshell, two observations deserve to be mentioned. First, it is obvious that HDG’s foreign exchange hedging processes is an important aspect of the company-wide operations. Second, the procedure used to establish an exchange rate for current business operations is multifaceted and may embrace systematic prejudices (Guay & Kothari 2003, p.423).

However, hedging with foreign exchange has two merits. First, it can enhance the ability of the finance department to make value-maximizing choices (i.e. pricing and investment decisions). When HDG opts to venture into a foreign market, the manner in which foreign exchange is treated is critical.

If foreign exchange hedging permits the company to implement its optimal investment plan, the value of the firm will ultimately increase. In essence, the ability of the firm to use a hedge rate not only affects its pricing policy but also reduces the ambiguity surrounding the investment decision in the foreign market (Pantzalis & Simkins 2001, p.793).

References

Ahn, D & Robert, F 1998, ‘Optional Risk Management Using Options’, Journal of Finance, vol. 54 no.1, pp. 359-375.

Brown, G 2001, ‘Managing foreign exchange risk with derivatives’, Journal of Financial Economic, vol. 60, pp. 401-448.

Core, J &Guay, W 2002, ‘Estimating the value of employee stock option portfolios and their sensitivities to price and volatility,’ Journal of Accounting Research, vol. 40 no. 613–630.

Drezner, D 2000. ‘Bottom feeders’, Foreign Policy, vol. 121, pp. 64-70.

Egan, M 2001, Constructing a European market: standards, regulations and governance, Oxford University Press, Oxford.

Graham, J & Rogers, D 2002, ‘Do firms hedge in response to tax incentives?’, Journal of Finance, vol. 57, pp. 815–839.

Guay, W & Kothari, S 2003, ‘How much do firms hedge with derivatives?’, Journal of Financial Economics, vol. 70, pp. 423-461.

Haufler, V 2003, New Forms of Governance: Certification Regimes as social Regulation of the Global Market, University of Maryland, Maryland.

Haufler, V 2001, A public role for the private sector: industry self-regulation in the global economy, Carnegie Endowment for International Peace, Washington, DC.

Hentschel, L & Kothari, S 2001, ‘Are corporations reducing or taking risks with derivatives?’, Journal of Financial and Quantitative Analysis, vol. 36, no. 93–116.

Higgins, P & Humpage, O 2005, Nondeliverable Forwards: Can We Tell Where the Renminbi is headed?, Federal Reserve Bank of Cleveland, Cleveland.

Pantzalis, C & Simkins, B 2001, ‘Operational hedges and the foreign exchange exposure of US multinational corporations’, Journal of International Business Studies, vol. 32, no. 793–812.

Roubini, N 2001, Should Argentina Dollarize or Float? The Pros and Cons of Alternative Exchange Rate Regimes and their Implications for Domestic and Foreign Debt Restructuring/Reduction, New York University, New York.

Spar, D 2001, Ruling the waves: cycles of discovery, chaos, and wealth from the Wompass to the internet, Harcourt, Inc., New York.

Wong, F2000, ‘The association between SFAS No. 119 derivatives disclosures and the foreign exchange risk exposure of manufacturing firms’, Journal of Accounting Research, vol. 38, no. 387–417.

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