Multinational Cost of Capital

Topics: Multinational corporation, Corporation, Globalization Pages: 11 (2007 words) Published: January 25, 2015

Multinational Cost of Capital
Capital Structure, Risk and the Cost of Capital for Multinational Companies (1713 words)

Table of Contents
Literature Review2
Capital Structure, Risk and the Cost of Capital for Multinational Companies2 Criticism to the work and the upstream-downstream hypothesis2 Conclusion2

“Theoretically, MNEs should be in a better position than their domestic counterparts to support higher debt ratios because their cash flows are diversified internationally.” (Eiteman, et al., 2013, p.386). However, recent empirical studies have come to a different conclusion. The following will be presented evidences found in the literature review that show that it is not always that companies reduce their risks and consequently the cost of capital when internationalize. Domestic firms can indeed have lower risk than multinationals. Factors as the host country and the companies’ internationalization degree should be also analysed.

Literature Review
Capital Structure, Risk and the Cost of Capital for Multinational Companies Studies on multinational capital structure have pointed in opposite directions, sometimes showing that multinationals are more indebted than domestic companies and occasionally that domestics are more indebted than multinationals. The first researches were conducted with United States companies and showed that multinationals from this country have lower debt ratios than their local counterparts. Another group of more recent studies in multinational companies based in countries such as France, Canada and Brazil has pointed out that multinational from these countries have higher debt ratios than their domestic peers. Although of paradox results, a plausible explanation may be found in the Reeb and Kwok (2000) work. The authors formulated the hypothesis called upstream-downstream which postulates that when a multinational is headquartered in a more stable economy and expands internationally to less stable economies, as in the case of studies with United States’ companies, the bankruptcy risk of these multinationals can increase, which increases the debt cost and inhibits further debt of these firms. So the more internationalized are these firms, tend to be lower their debt levels. On the other hand, companies whose headquarters are in countries with less stable economies, which have features such as financial constraints and higher systemic risks, to internationalize can reduce their bankruptcy risk and therefore may be more leveraged than their domestic peers. Thus, for these companies the greater the degree of internationalization, the greater the debt. It is impossible to deny the theoretical contribution of Kwok and Reeb (2000) work and empirical contributions that validate the upstream-downstream hypothesis offered by the recent work of Saito and Hiramoto (2010), Mittoo and Zhang (2008) and Singh and Nejadmalayeri (2004). Such studies make up the latest evidence on the subject and are relevant in understanding that the companies have capital structures (measured by total debt, short and long term) different according to the higher or the lower risk they incur to go abroad. Thus, the hypothesis upstream-downstream can explain the contradictory evidence, one important theory used to understand the multinationals debt and cost of capital. The incentive for studies on multinational capital structure emerge from the fact that the multinationals, unlike domestic companies have to deal with greater institutional variability because they act both in home and outside the country. Companies dedicated to internationalization activities have higher demands for financing compared with companies that are restricted to their home markets, and can diversify their risk among different markets (Shapiro, 1978). For these reasons, it was thought that multinational companies should have higher leverage compared to...

References: Burgman, T. A., 1996. An Empirical Examination of Multinational Corporate Capital Structure. Journal of International Business Studies, 27(3), pp. 553-570.
Chen, C. J. P., Cheng, C. S. A., He, J. & Kim, J., 1997. An investigation of the relationship between international activities. Journal of International Business Studies, 28(3), pp. 563-577.
Eiteman, D. K., Stonehill, A. I. & Moffett, M. H., 2013. Multinational Business Finance. 13th ed. Harlow: Pearson.
Kwok, C. C. Y. & Reeb, D. M., 2000. Internationalization and firm risk: An upstream-downstream hypothesis. Journal of International Business Studies, 31(4), pp. 611-629.
Lee, K. C. & Kwok, C. C. Y., 1988. Multinational Corporations vs. Domestic Corporations: International Environmental Factors and Determinants of Capital Structure. Journal of International Business Studies, 19(2), pp. 195-217.
Mittoo, U. R. & Zhang, Z., 2008. The capital structure of multinational corporations: Canadian versus US evidence. Journal of Corporate Finance, 14(5), pp. 706-720.
Saito, R. & Hiramoto, E., 2010. Foreign activity effects and capital structure: Brazilian evidence. Academia Revista Latinoamericana de Administración, 45(1), pp. 59-75.
Shapiro, A. C., 1978. Financial structure and cost of capital in the multinational corporation. Journal of Financial and Quantitative Analysis, 13(2), pp. 211-226.
Singh, M. & Nejadmalayeri, A., 2004. Internationalization, capital structure, and costof capital: Evidence from French corporations. Journal of Multinational Financial, 14(2), pp. 153-169.
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