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Finance Function in a Global
108 Harvard Business Review
by Mihir A. Desai
HISTORICALLY, the ﬁnance functions in large U.S. ...view middle of the document...
There is also a critical managerial component: What looks like savvy ﬁnancial management can ruin individual and organizational motivation. As we’ll see in the following pages, some of the ﬁnancial opportunities available to global ﬁrms are affected by institutional and managerial forces in three critical functions: ﬁnancing, risk management, and capital budgeting.
Financing in the Internal Capital Market
Institutional differences across a company’s operations allow plenty of scope for creating value through wise ﬁnancing decisions. Because interest is typically deductible, a CFO can signiﬁcantly reduce a group’s overall tax bill by borrowing disproportionately in countries with high tax rates and lending the excess cash to operations in countries with lower rates. CFOs can also exploit tax differences by carefully timing and sizing the ﬂows of proﬁts from subsidiaries to the parent. However, tax is not the only relevant variable: Disparities in creditors’ rights around the world result in differences in borrowing costs. As a consequence, many global ﬁrms borrow in certain foreign jurisdictions or at home and then lend to their subsidiaries.
Multinational ﬁrms can also exploit their internal capital markets in order to gain a competitive advantage in countries when ﬁnancing for local ﬁrms becomes very expensive. When the Far East experienced a currency crisis in the 1990s, for example, and companies in the region were struggling to raise capital, a number of U.S. and European multinationals decided to increase ﬁnancing to their local subsidiaries. This move allowed them to win both market share and political capital with local governments, who interpreted the increased ﬁnancing as a gesture of solidarity. But the global CFO needs to be aware of the downside of getting strategic about ﬁnancing in these ways. Saddling the managers of subsidiaries with debt can cloud their proﬁt performance, affecting how they are perceived within the larger organization and thereby limiting their professional opportunities. Similar considerations should temper companies’ policies about the repatriation of proﬁts. For U.S. companies, tax incentives dictate lumpy and irregular proﬁt transfers to the parent. But many ﬁrms choose to maintain smooth ﬂows of proﬁts from subsidiaries to the parent because the requirement to disgorge cash makes it harder for managers to inﬂate their performance through fancy accounting. Finally, letting managers rely too much on easy ﬁnancing from home saps their autonomy and spirit of enterprise, which is why many ﬁrms require subsidiaries to borrow locally, often at disadvantageous rates.
Managing Risk Globally
The existence of an internal capital market also broadens a ﬁrm’s risk-management options. For example, instead of managing all currency exposures through the ﬁnancial market, global ﬁrms can offset natural currency exposures through their worldwide operations. Let’s say a European subsidiary purchases local components...