Local capital structures
Each country has unique economic characteristics that may either impede or promote entrepreneurship. For a Multinational Corporation (MNC) operating at a local level, a given subsidiary might be compelled to use either equity or debt. It is crucial to observe that the latter situation can prevail even if economic balance exists within the capital structure of the MNC’s global target.
In the event that the stock market of an economy is poorly developed, it is highly likely that most multinational corporations may evade such markets. The main reason for such evasion is poor profit margin that cannot even sustain the operations of a subsidiary (Shapiro, 2010).
After assessing and making sure that a country’s stock market is below par, a multinational company may simply delay or even completely avoid issuing stock. In this regard, bank loans and other sources of debts may be used by an MNC to finance a subsidiary.
A balance sheet contains components that comprise of an important part of the financial structure. This should not be misconstrued with capital structure. When the financial structure is represented over a long period, it is referred to as the capital structure. It is also vital to mention that both owner’s equity and liabilities constitute the capital structure of a multinational corporation.
A particular subsidiary may also be facing a number of operational challenges emanating from lack of adequate funds. In such a case, it may be necessary for a multinational firm to construct capital structure only in the affected subsidiary without necessarily affecting or interfering with global operations.
If this procedure is executed properly, it can assist in reducing the total financing cost affecting a particular subsidiary. This implies that the value of debt financing is significantly reduced (Moyo, Wolmarans & Brümmer, 2014). Although both equity and debt financing options may be used in a local subsidiary of a multinational company, the latter method is mostly preferred owing to several advantages associated with it.
The possibilities of potential bankruptcy risk and continuous financial liabilities can also be minimized when capital structure is applied at a local subsidiary. As already hinted out, cost reduction stands out as a major factor usually considered by multinational corporations that carry out local capital structures. It is always necessary to reduce the total financing cost in a particular subsidiary under consideration.
Moreover, periodic interest payments can be made at a local subsidiary and hence less risk is directed towards debt holders. Equity holders may indeed face numerous risks when it comes to capital structuring at a lower subsidiary. Besides, senior claiming rights can be easily secured by debt holders in case a corporation goes into liquidation.
Needless to say, such rights can further guarantee debt holders additional protection layer for all the capital plough-backs they have in place. Better still; the most minimum cost compensation is a major booster or requirement for safer debt investment (Moyo, Wolmarans & Brümmer, 2014).
Global capital structures
Within a global setup, it might be very tricky and challenging to retain profit through capital structures bearing in mind that operations are vastly widespread. Profit retention can be easily realized when local capital structures are executed in domestic subsidiaries.
It is obvious that equity payments cannot assist in retaining profits because they are mostly applied in global operations. The profits earned by an organization at the international level are usually shared out to different operations. This results into reduced revenue in the end. However, local subsidiaries are in a position to grow their capital base through profit retention when operations are financed through debts.
A particular subsidiary of a multinational organization also stands a better chance to leverage on the financial benefits associated with domestic or local operations. For example, financing using debts through local capital structures is a major gain for existing owners (Shapiro, 2010). When debt is used by multinational corporations to avail surplus capital, all the additional profits generated are kept by equity owners.
As a matter of fact, it is vital to underscore the fact that the debt capital also generates its own profit margin. Equity owners cannot benefit in the same level for operations that are carried out by organizations at the global level. Financial leveraging may also be found necessary in specific subsidiaries that are struggling or still not stable. It may also be suitable if shareholders (equity owners) are struggling to make any significant profits.
Since equity owners have a better opportunity to make higher returns in a local capital structure, it is also the best way of motivating them. If the financial soundness of a particular subsidiary cannot be jeopardized by the local financial arrangement, just a small number of shareholders may prefer this type of undertaking and that is why multinational corporations will execute such measures in specific subsidiaries (Shapiro, 2010).
On a final note, local capital structures generate major leads in tax savings. Taxes accrued by an organization can be remarkably lowered when debts are utilized to inject additional capital. This scenario is possible due to the allowable interest deductions that eventually culminate into taxable incomes. Global capital structures can hardly generate such leads.
References
Moyo, V., Wolmarans, H., & Brümmer, L. (2014). The discounted value premium: A new way of looking at the capital structure puzzle. Management Dynamics, 23(1), 2- 25.
Shapiro, C.A. (2010). Multinational Financial Management (9th ed). New York: John Wiley & Sons, Inc.