How financial management helps in maximizing shareholder wealth through effective utilization of resources?

Answer 1

Like any finance function, international finance, the finance function of a multinational firm has two functions namely, treasury and control. The treasurer is responsible for financial planning analysis, fund acquisition, investment financing, cash management, investment decision and risk management. On the other hand, controller deals with the functions related to external reporting, tax planning and management, management information system, financial and management accounting, budget planning and control, and accounts receivables etc. For maximising the returns from investment and to minimise the cost of finance, the firms has to take portfolio decision based on analytical skills required for this purpose. Since the firm has to raise funds from different financial markets of the world, which needs to actively exploit market imperfections and the firm’s superior forecasting ability to generate purely financial gains. The complex nature of managing international finance is due to the fact that a wide variety of financial instruments, products, funding options and investment vehicles are available for both reactive and proactive management of corporate finance.

Multinational finance is multidisciplinary in nature, while an understanding of economic theories and principles is necessary to estimate and model financial decisions, financial accounting and management accounting help in decision making in financial management at multinational level. 5 Because of changing nature of environment at international level, the knowledge of latest changes in forex rates, volatility in capital market, interest rate fluctuations, macro level charges, micro level economic indicators, savings, consumption pattern, interest preference, investment behaviour of investors, export and import trends, competition, banking sector performance, inflationary trends, demand and supply conditions etc. is required by the practitioners of international financial management.

Distinguishing features of international finance International Finance is a distinct field of study and certain features set it apart from other fields. The important distinguishing features of international finance from domestic financial management are discussed below:

1. Foreign exchange risk : An understanding of foreign exchange risk is essential for managers and investors in the modern day environment of unforeseen changes in foreign exchange rates. In a domestic economy this risk is generally ignored because a single national currency serves as the main medium of exchange within a country. When different national currencies are exchanged for each other, there is a definite risk of volatility in foreign exchange rates. The present International Monetary System set up is characterised by a mix of floating and managed exchange rate policies adopted by each nation keeping in view its interests. In fact, this variability of exchange rates is widely regarded as the most serious international financial problem facing corporate managers and policy makers. At present, the exchange rates among some major currencies such as the US dollar, British pound, Japanese yen and the euro fluctuate in a totally 6 unpredictable manner. Exchange rates have fluctuated since the 1970s after the fixed exchange rates were abandoned. Exchange rate variation affect the profitability of firms and all firms must understand foreign exchange risks in order to anticipate increased competition from imports or to value increased opportunities for exports.

2. Political risk: Another risk that firms may encounter in international finance is political risk. Political risk ranges from the risk of loss (or gain) from unforeseen government actions or other events of a political character such as acts of terrorism to outright expropriation of assets held by foreigners. MNCs must assess the political risk not only in countries where it is currently doing business but also where it expects to establish subsidiaries. The extreme form of political risk is when the sovereign country changes the ‘rules of the game’ and the affected parties have no alternatives open to them. For example, in 1992, Enron Development Corporation, a subsidiary of a Houston based energy company, signed a contract to build India’s longest power plant. Unfortunately, the project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not require the power plant. The company had spent nearly $ 300 million on the project. The Enron episode highlights the problems involved in enforcing contracts in foreign countries. Thus, episode highlights the problems involved in enforcing contracts in foreign countries. Thus, political risk associated with international operations is generally greater than that associated with domestic operations and is generally more complicated.

3. Expanded opportunity sets: When firms go global, they also tend to benefit from expanded opportunities which are available now. They can raise funds in capital 7 markets where cost of capital is the lowest. In addition, firms can also gain from greater economies of scale when they operate on a global basis.

4. Market imperfections: The final feature of international finance that distinguishes it from domestic finance is that world markets today are highly imperfect. There are profound differences among nations’ laws, tax systems, business practices and general cultural environments. Imperfections in the world financial markets tend to restrict the extent to which investors can diversify their portfolio. Though there are risks and costs in coping with these market imperfections, they also offer managers of international firms abundant opportunities.

1.3 GOALS FOR INTERNATIONAL FINANCIAL MANAGEMENT

The foregoing discussion implies that understanding and managing foreign exchange and political risks and coping with market imperfections have become important parts of the financial manager’s job. International Financial Management is designed to provide today’s financial managers with an understanding of the fundamental concepts and the tools necessary to be effective global managers. Throughout, the text emphasizes how to deal with exchange risk and market imperfections, using the various instruments and tools that are available, while at the same time maximizing the benefits from an expanded global opportunity set. Effective financial management, however, is more than the application of the newest business techniques or operating more efficiently. There must be an underlying goal. International Financial Management is written from the perspective that the fundamental goal of sound financial management is shareholder wealth maximization. Shareholder wealth 8 maximization means that the firm makes all business decisions and investments with an eye toward making the owners of the firm– the shareholders– better off financially, or more wealthy, than they were before. Whereas shareholder wealth maximization is generally accepted as the ultimate goal of financial management in ‘Anglo-Saxon’ countries, such as Australia, Canada, the United Kingdom, and especially the United States, it is not as widely embraced a goal in other parts of the world. In countries like France and Germany, for example, shareholders are generally viewed as one of the ‘stakeholders’ of the firm, others being employees, customers, suppliers, banks, and so forth. European managers tend to consider the promotion of the firm’s stakeholders’ overall welfare as the most important corporate goal. In Japan, on the other hand, many companies form a small number of interlocking business groups called keiretsu, such as Mitsubishi, Mitsui, and Sumitomo, which arose from consolidation of family- owned business empires. Japanese managers tend to regard the prosperity and growth of their keiretsu as the critical goal; for instance, they tend to strive to maximize market share, rather than shareholder wealth. Obviously, the firm could pursue other goals. This does not mean, however, that the goal of shareholder wealth maximization is merely an alternative, or that the firm should enter into a debate as to its appropriate fundamental goal. Quite the contrary. If the firm seeks to maximize shareholder wealth, it will most likely simultaneously be accomplishing other legitimate goals that are perceived as worthwhile. Share-holder wealth maximization is a long-run goal. A firm cannot stay in business to maximize shareholder wealth if it treats employees poorly, produces shoddy merchandise, wastes raw materials and Natural Resources, operates inefficiently, or fails to satisfy customers. Only a well managed business firm that profitably produces what is demanded in an 9 efficient manner can expect to stay in business in the long run and thereby provide employment opportunities. Shareholders are the owners of the business; it is their capital that is at risk. It is only equitable that they receive a fair return on their investment. Private capital may not have been forthcoming for the business firm if it had intended to accomplish any other objective.

Answer 2

Financial management helps in maximizing shareholder wealth through effective utilization of resources by ensuring efficient allocation of funds to profitable projects and investments. It involves making sound financial decisions such as capital budgeting, capital structure management, and dividend policy. By optimizing the use of available resources and adopting strategies that enhance profitability, financial management helps in generating higher returns for shareholders.