Question

Discuss how is multinational firm riskier than purely domestic firm? Please, give evidences in different perspectives.

Answer 1

-Multinational companies are exposed to the risk of political and foreign exchange risk. It is difficult for the MNCs to diversify or reduce these risks.

-The debt ratio is lower when there is a decrease in business risk because of low earning volatility through international diversification, and this risk is more than offset by additional exchange rate risk and political risk. MNCs could have a lower debt ratio than domestic companies because the integration of the world economy precludes business risk reductions through international diversification. Also, it is possible that multinational companies incur higher agency costs of debt financing than domestic companies, thus there is systematic differences in agency costs between MNCs and domestic companies.

-There is a difference in currency denominations in the case of MNCs as they operate in different companies.

-Economic and legal systems- Every country has its own legal and economic systems , these differences can cause coordination problem and control of its subsidiaries or branches across the globe. For example-differences in legal systems of host nations, such as the Common Law of Great Britain versus the French Civil Law, complicate matters ranging from the simple recording of business transactions to the role played by judiciary in resolving conflicts. Such differences make difficult for companies flexibility..

-There is a difference in language- Communication is most important for trade. In the US, citizens are fluent in English only, whereas European and Japanese are fluent in many languages including English. Thus they can invade the US and other markets easily.

-Cultural differences- Different countries have different cultures that are required to be considered. For example in India beef is against the culture of Indians, therefore dominoes and other food companies avoid using beef in their food items.

-Government regulation- Government through its power establish basic rules that are involved in the process. For example entry for an MNC is determined by its entrance in a country. India when liberalized in 1991 allowed foreign companies to trade inside and this becomes the basis for many MNCs that are now well furnished and earning huge profits here.

But as we all know with risk comes rewards, with many risks, they also take advantage of international diversification that reduces their risks. Most of the general market risk for domestic companies are cyclical in nature. By trading across countries diversifies this risk also as every country has a different economic cycle, thus reduces variations in earnings of the company and maintaining a stable earning. Therefore diversification eliminates the risk of operating in a single country (home country). Trading or dealing across borders allows MNCs to retaliate or respond /react back immediately against foreign companies intrusion in the domestic market and track their competitor more closely that reduces the risk of being blindsided by new and latest developments of other countries .