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Foreign portfolio investment

Jamal Munshi, Sonoma State Univesity, 1992
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COST OF CAPITAL: key variable from MNC point of view
  • FIRM = PORTFOLIO OF PROJECTS
  • FDI analysis as portfolio investment
  • PROJECT RISK = VARIANCE-COVARIANCE MATRIX
  • SIMPLE CASE = EXISTING FIRM + NEW PROJECT
  • Rnew = (1-w)Rfirm + wRproj
  • Vnew = (1-w)Vfirm + wVproj + (1-w)wCOVfp
  • CAPM APPROACH: firm is the market portfolio:
  • Unanswered question: How does project affect firm beta?
  • Can a change in capital structure at fixed operating conditions change firm value?
  • [borrow money and repurchase shares: new stock issue to retire debt]
  • Miller Irrelevancy: NO
  • Hamada equation: YES
  • Domestic diversification: no shareholder value since shareholders can diversify by purchasing shares. International diversification: capital market imperfections -: costly information and transacting -: shareholder wealth to FDI diversification
  • changing?
  • Value of international FDI:financing diversification
  • covariance effect argument
  • technology transfer argument (wealth=licensing fee)
  • transaction cost argument
  • underinvestment argument (IOS should contain all projects)
  • value of international financing:
  • capital market imperfections
  • structural
  • informational
  • regulatory
us-japan cost of capital
  • old argument: japanese investment in capital intensive long term projects is cost of capital issue not myopia issue. more debt -: lower cost of capital -: more investment -: higher firm value
  • problem with this argument: capital structures have equalized
  • japanese raised $125b overseas: inexplicable if lower cost of capital at home: what about currency issues? also 125 is not a large sum
  • problems with comparing capital structure across countries:
  • what is debt? look at contractual details and organization of businesses: is japanese debt really debt?
  • effect of japanese crossholdings -: japanese firms start out in chapter 13 bankruptcy. mutual hostage taking. direct managerial role of banks: crossholdings: reduces total tse capitalization by half
comparison of mazda and chrysler
  • bank financing vs development of capital markets: japan and germany catching up.
  • coping with cost of capital disadvantage
  • big question: is there one? if so what is the source of the disadvantage? where is the wealth coming from? one possibility: agency costs
  • ways to compensate: "reduce capital intensity" is wrong -: productivity issues. increase asset utilization. how? working capital mgt, capital equip quality and maintenance, worker knowledge and skill -: education education education
  • p:e ratio comparison
  • japan:usa
  • per -: growth + beta risk: confounded: a lousy measure
  • analysis based on no growth: problems with this assumption
  • another problem with per analysis: japanese crossholdings
  • crossholdings estimated to acct for 50% of market capitaliztion
  • comparison of us and japanese unlevered beta returns (3.44 and 3.450 based on hamada eqn
  • another approach: japanese market risk premium is lower for social and cultural reasons: agency costs:
  • empirical literature on the topic is confusing because no clear theory for dealing with market integration issues.
novo industri case
  • international financing to lower cost of capital and increase firm value
  • imperfections in global capital markets
  • danish regulations
  • adr
  • nyse listing
  • sec disclosure
  • us accounting
  • costly information:transacting

rise in novo share priceswhere did this wealth come from?