Besides international trade, FDI by multinational corporations is a great force that is driving globalization of “the world economy” (Eun & Resnick, 2007).
According to the report presented by the UN, there are more than six hundred thousand multinational corporations across the world with more than a half a million foreign affiliates (Eun & Resnick, 2007).
In the course of the 1990s, these corporations’ FDI increased at the rate of ten percent annually while international trade’s annual growth rate was 3.5 percent in the same period (Eun & Resnick, 2007).
Moreover, it is reported that the worldwide MNCs’ sales increased to eleven trillion dollars in the year 1998, “compared to about $7 trillion of world exports in the same year” (Eun & Resnick, 2007, p.15). It is indicated that the multinational corporations are influencing the global economy.
In this paper, there is going to be a discussion on MNCs and what motivates them to invest overseas. There is also going to be a discussion about different risks these corporations face and how they manage them.
A multinational corporation can be defined as “a business firm incorporated in one country that has production and sales operations in several other countries” (Eun & Resnick, 2007, p.15).
This involves a situation where a firm acquires the sales operations and production from one national market and the financial capital from another; producing commodities “with labor and capital equipment in a third country, and selling the finished product in yet other national markets” (Eun & Resnick, 2007, p.15).
Certainly, among the MNCs, there are those that carry out business operations in various nations. They receive funding from the main money market centres across the globe in various currencies.
It is pointed out that “global operations force the treasurer’s office to establish international banking relationships, place short-term funds in several currency dominations, and effectively manage foreign exchange risk” (Eun & Resnick, 2007, p.15).
The benefits that the MNCs can gain from investing overseas are the motivating factors for making such investments (Eun & Resnick, 2007). They may gain from having a global presence in a number of ways.
Firstly, they can gain from the economies of scale which may be realized though undertaking various activities. For instance, they may realize this by engaging in spreading expenditures of research and development and costs of advertising over sales made on the international market.
Moreover, they can realize economies of scale by “pooling the global purchasing power over suppliers” (Eun & Resnick, 2007, p.17). They can also realize this by using the managerial and technological skills internationally, with very low extra costs.
Another gain from investing overseas is that these corporations can utilize their worldwide presence to capitalize on the lower labor service prices that are found in particular developing nations, and in turn acquire “access to special R&D capabilities residing in advanced foreign countries” (Eun & Resnick, 2007, p.17).
Without any doubt, the MNCs can engage in leveraging their worldwide presence in order to increase profit margins and also to realize value creation (Eun & Resnick, 2007).
The emerging markets are quite attractive and present great opportunities for the MNCs to invest. However, these markets are greatly unpredictable and may present various political risks.
Under international finance, a political risk is said to exist in a situation where the political change can contribute towards having discontinuities within the business environment which are very hard to foresee.
According to Thunnel (1977), there are two types of political risks; one of them is sovereign risk. This occurs in the host nations where a MNC can be affected by either social or government instability which may involve having revolutions and political strikes among others.
The other type involves risks that occur between the host nation and the home country of the MNC, and this may involve having wars, trade frictions and “cross-currency control risks” (Liu & Bjornson, 1998, p.362).
The biggest risk that the multinational corporations face is “expropriation or nationalization of their investment, and forced withdrawal from the host country” (Liu & Bjornson, 1998, p.362).
Expropriation may involve a host nation engaging in appropriating the rents or profits of the multinational corporation by rising the levels of taxes imposed on direct foreign investment or otherwise, utilizing its authority to moderately expropriate (Liu & Bjornson, 1998).
The MNCs manage risks that they face through various ways. One of them is through insurance. Several developed nations engage in selling the political risk insurance in order to cover the domestic companies as well as foreign assets.
For instance, in 1979, the United States government set up the “’Overseas Private Investment Corporation’ which provides insurance against expropriation, currency inconvertibility, political violence, and also loss of business income from interruptions to DFI operations” (Liu & Bjornson, 1998, p.363).
In 1988, MIGA or “Multinational Investment Guarantee Agency” was set up in order to boost “investment for economic development by insuring foreign investment against currency transfer restrictions, expropriation, war, civil disturbances, and breach of contract” (Liu & Bjornson, 1998, p.363).
The MNCs also manage the risk exposure by negotiating the environment. They do this by making concession agreements with the government of the host country before investing. They define the responsibilities as well as the rights of these two parties.
These may include having tax breaks, constructing the infrastructure and having property rights that are defined in a clear manner.
The “negotiating environment” approach was used in the case that involved China as a host country and McDonald’s in 1994, to deal with the issue of property rights (Liu & Bjornson, 1998). The other effective approach is to restructure the investment.
Basing on this approach, the multinational corporations seek to bring down the level of their exposure to risks by “increasing the host country’s cost of interference with company operations” (Liu & Bjornson, 1998, 363).
Among the strategies of this nature is vertical integration which “keeps the local affiliate dependent on external MNC subsidiaries for inputs or market” (Liu & Bjornson, 1998, 363).
In conclusion, it has been established in the discussion that the multinational corporations are motivated to invest in foreign countries by the potential benefits that such investments bring.
By investing overseas, they can gain from the economies of scale and may also be able to take advantage of the lower labor costs that are found mostly in developing nations.
However, the MNCs also face political risks such as revolutions, political strikes, wars, trade frictions and “cross-currency control risks” among others.
The MNC have been managing these risks by using such approaches as taking insurance cover, negotiating the environment and restructuring the investment among others.
Eun, C.S. & Resnick, B.G. (2007). International Financial Management. (4th ed.)New York, NY: McGraw-Hill.
Liu, Y. & Bjornson, B. (1998). Managing exposure of direct foreign investment to political risk: The case of food businesses in China. International Food and Agribusiness Management Review, 1(3), 359 – 372.
Thunnel, H. L. (1977). Political risk in international business: Investment behaviour of multinational corporations. New York, NY: Prager Publishers.