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Chapter: Business Science - International Business Management - Production, Marketing, Financial and Human Resource Management of Global Business

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Investment Decisions

The proliferation of multinational corporations (hereinafter referred to as MNCs) began 200 years ago, but they were making only a part of the foreign investment in different countries in the form of portfolio rather than long term Greenfield or joint venture investments.

INVESTMENT DECISIONS:

 

The proliferation of multinational corporations (hereinafter referred to as MNCs) began 200 years ago, but they were making only a part of the foreign investment in different countries in the form of portfolio rather than long term Greenfield or joint venture investments.

With the increase of globalization, which is both the cause and the effect of internationalization of world trade,

 

 MNCs have become dominant players in the global economy. Although severely affected by the economic and financial crisis, and expected to fall from $1.7 trillion of 2008 to below $1.2 in 2009, the foreign direct investment (FDI) by MNCs have been paid great importance for high economic growth and strong economic performance in many parts of the world.

 

he end of the Cold War which led to the liberalization of the developing markets and opening of their economies with the removal of foreign investment barriers, privatization of the state economic enterprises and development of FDI attractive policies, has increased the investment of MNCs, especially in the developing countries. Latin America, Eastern Europe and Asian economies have become predominantly FDI focused first with labor-intensive manufacturing industries and then with market-seeking FDI by 1990’s.

 

            While MNCs are struggling to get an accurate answer for the "where to invest"

        Question, countries have got into the competition of "attracting more FDI"

 

         To "become hosts to branch plants of MNCs as well as to small- and medium-sized firms from developed countries"

 

            Particularly after 1990’s. FDI not only "has become by far the single largest component of their net capital inflows"

 

        but it also has become critical for these countries in terms of their effects on the human capital of the economies.

 

            These countries not only try to benefit from the financial aspects of investment, they also try to get best practices, transfer knowledge with new ideas and technologies and adopt managerial skills and new methods of managing companies.

 

            Additionally, investments of the MNCs in developing countries have played a significant role in the process of integration of developing countries with other countries of the world, which is referred to as economic openness, via increasing imports and exports and integrating firms, particularly SME’s into the global supply chain.

 

            In this global picture, it would be better to analyze the evolution of investment of MNCs in Turkey after early 1980’s, when markets were liberalized and import substitution policies were left. The decrease in the importance of government’s role in overall economy with the privatization of state enterprises and commercial and legal reforms aimed at attracting MNCs to Turkey, but the share Turkey had from worldwide FDI investments remained low until 2000’s.

 

            After structural reforms, the political stability, economic growth of the domestic market, which increased annually by 6% from 2002 to 2008 in terms of annual average real GDP

 

            Increase in the government focus on FDI and as a result, increased openness of the country with local competitive environment

 

            Have changed the figures and Turkey has become the "target for foreign direct investment as it is both an efficient production base and an important market for delivery of goods and services."

 

This paper aims to analyze the determinants of the MNCs’ investments in different counties with a focus on Turkey. First of all, the growing importance of MNCs in global economy and their intentions to act globally will be analyzed. Secondly, different determinants of international investment decisions such as legal and commercial determinants will be discussed. Afterwards, investment policies of developing countries and their reforms will be elaborated taking Turkey as a topic of analysis and Turkey’s investment environment will be discussed. In the conclusion, problems and different risks (commercial, political, legal risks) which an MNC may face in investing in Turkey will be analyzed.

 

There are different ways you can invest internationally: through mutual funds, American Depositary Receipts, exchange-traded funds, U.S.-traded foreign stocks, or direct investments in foreign markets. This online brochure explains the basic facts about international investing and how you can learn more about foreign companies and markets. Although this brochure covers foreign stocks, much of it also applies to foreign bonds.

 

Types of Business Risks

 

 

Business risks are of a diverse nature and arise due to innumerable factors. These risks may be broadly classified into two types, depending upon their place of origin.

 

Internal Risks are those risks which arise from the events taking place within the business enterprise. Such risks arise during the ordinary course of a business. These risks can be forecasted and the probability of their occurrence can be determined. Hence, they can be controlled by the entrepreneur to an appreciable extent.

 

The various internal factors giving rise to such risks are:-

 

Human factors are an important cause of internal risks. They may result from strikes and lock-outs by trade unions; negligence and dishonesty of an employee; accidents or deaths in the industry; incompetence of the manager or other important people in the organization, etc. Also, failure of suppliers to supply the materials or goods on time or default in payment by debtors may adversely affect the business enterprise.

 

Technological factors are the unforeseen changes in the techniques of production or distribution. They may result in technological obsolescence and other business risks. For example, if there is some technological advancement which results in products of higher quality, then a firm which is using the traditional technique of production might face the risk of losing the market for its inferior quality product.

 

Physical factors are the factors which result in loss or damage to the property of the firm. They include the failure of machinery and equipment used in business; fire or theft in the industry; damages in transit of goods, etc. It also includes losses to the firm arising from the compensation paid by the firm to the third parties on account of intentional or unintentional damages caused to them.

 

External risks are those risks which arise due to the events occurring outside the business organization. Such events are generally beyond the control of an entrepreneur. Hence, the resulting risks cannot be forecasted and the probability of their occurrence cannot be determined with accuracy.

 

The various external factors which may give rise to such risks are :-

 

Economic factors are the most important causes of external risks. They result from the changes in the prevailing market conditions. They may be in the form of changes in demand for the product, price fluctuations, changes in tastes and preferences of the consumers and changes in income, output or trade cycles. The conditions like increased competition for the product, inflationary tendency in the economy, rising unemployment as well as the fluctuations in world economy may also adversely affect the business enterprise. Such risks which are caused by changes in the economy are known as 'dynamic risks'. These risks are generally less predictable because they do not appear at regular intervals. Also, such risks may not necessarily result in losses to the firm because they may also contain an element of gain for the firm. For instance, due to market fluctuations well known product of a firm may either lose its demand or may occupy a larger market share.

 

Natural factors are the unforeseen natural calamities over which an entrepreneur has very little or no control. They result from events like earthquake, flood, famine, cyclone, lightening, tornado, etc. Such events may cause loss of life and property to the firm or they may spoil its goods. For example, Gujarat earthquake caused irreparable damage not only to the business enterprises but also adversely affected the whole economy of the State.

 

Political factors have an important influence on the functioning of a business, both in the long and short term. They result from political changes in a country like fall or change in the Government, communal violence or riots in the country, civil war as well as hostilities with the neighboring countries. Besides, changes in Government policies and regulations may also affect the profitability and position of a enterprise. For instance, changes in industrial and Trade policy annual announcement of the budget amendments to various legislations, etc. may enhance or reduce the profits of a business enterprise.

 

Market Risk: The risk that the value of your investment will decline as a result of market conditions. This type of risk is primarily associated with stocks. You might buy the stock of a promising or successful company only to have its market value fall with a generally falling stock market.

 

Interest Rate Risk: The risk caused by changes in the general level of interest rates in the marketplace. This type of risk is most apparent in the bond market because bonds are issued at specific interest rates. Generally, a rise in interest rates will cause a decline in market prices of existing bonds, while a decline in interest rates tends to cause bond prices to rise. For example, say you buy a 30-year bond today with a 6% annual yield. If interest rates rise, a new 30-year bond may be issued with an 8% annual yield. The price of your bond drops because investors aren’t willing to pay full value for a bond that yields less than the current rate of interest.

 

Inflation or Purchasing Power Risk: The risk that the return on your investment will fail to outpace inflation. This type of risk is most closely associated with cash/stable value investments. Thus, although you may think a traditional bank savings account is relatively risk free, you actually could be losing purchasing power unless the interest rate on the account exceeds the current rate of inflation.

 

Some risks are unique to specific investment non-systematic risks.

 

Business Risk: This is the risk that issuers of an investment may run into financial difficulties and not be able to live up to market expectations. For example, a company’s profits may be hurt by a lawsuit, a change in management or some other event.

 

Credit Risk: For bonds, this is the risk that the issuer may default on periodic interest payments and/or the repayment of principal. For stocks, it is the risk that the company might reduce or eliminate dividend payments due to financial troubles.

 

When can invest internationally, the additional risks are also there,

 

Exchange Rate Risk: This is the risk that returns will be adversely affected by changes in the exchange rate.

Country or Political Risk: This is the risk that arises in connection with uncertainty about a country’s political environment and the stability of its economy. This risk is especially important in emerging markets.

 

1 ECONOMIC RISK:

 

It is the chance that macroeconomic conditions like exchange rates, government regulation, or political stability will affect an investment, usually one in a foreign country.

 

How it works/Example:

 

   For example, let's assume American Company XYZ invests $1,000,000 in a manufacturing plant in the Congo. Aside from the business risk associated with making the plant profitable, Company XYZ is exposed to economic risk.

 

   The political environment could shift quickly, perhaps prompting the Congolese government to seize the plant or significantly change laws that affect Company XYZ's ability to operate the plant.

 

   Likewise, hyperinflation could make it impossible to pay workers, or exchange rate circumstances could make it unprofitable to move profits out of the country.

 

Why it Matters:

 

   Economic risk is one reason international investing carries more risk than domestic investing. Shareholders and bondholders often bear the economic risk undertaken by international companies like Company XYZ. Investors who purchase and sell foreign government bonds are also exposed.

 

   Economic risk may also add opportunity for investors. Foreign bonds, for example, allow investors to participate indirectly in the foreign exchange markets and the interest rate environments of different countries. But the foreign regulatory authorities may impose different requirements on the types, sizes, timing, credit quality, disclosures, and underwriting of bonds issued in their countries.

 

Economic risk can be mitigated by opting for international mutual funds because they provide instant diversification, often investing in a variety of countries, instruments, currencies, or international industries.

 

2 POLITICAL RISK:

 

It is a type of risk faced by investors, corporations, and governments. It is a risk that can be understood and managed with reasoned foresight and investment.

 

Broadly, political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions or “any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives”. Political risk faced by firms can be defined as “the risk of a strategic, financial, or personnel loss for a firm because of such nonmarket factors as macroeconomic and social policies (fiscal, monetary, trade, investment, industrial, income, labor, and developmental), or events related to political instability (terrorism, riots, coups, civil war, and insurrection).”Portfolio investors may face similar financial losses. Moreover, governments may face complications in their ability to execute diplomatic, military or other initiatives as a result of political risk.

 

 

For multinational compa nies, political risk refers to the risk that a host country will make political decisions that will pro ve to have adverse effects on the multinational's profits and/or goals. Adverse political actions can range from very detrimental, such as widespread destruction due to revolution, to those of a more financial nature, such as the creation of aws that prevent the movement of capital.

 

In general, there are two types of political risk,

            Macro risk and micro risk.

            Macro risk

 

They refer to adverse actions that will affect all foreign firms, such as expropriation or insurrection, whereas micro risk refers to adverse actions that will only affect a certain industrial sector or business, such as corruption and prejudicial actions against compan ies from foreign countries. All in all, regardless o f the type of political risk that a multinational c orporation faces, companies usually will end up losing a lot of money if they are unprepared for these adverse situations. For example, after Fi del Castro's government took control of Cuba i n 1959, hundreds of millions of dollars worth o f American-owned assets and companies w ere expropriated. Unfortunately, most, if not all, o f these American companies had no recourse for getting any of that money back.


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