Desai Finance Function In A Global

2253 words - 10 pages


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...

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