A Multinational corporation is the firm engaged in foreign direct investment and state control over state-owned or value-added. The multinational corporation is appearing different conditions in the world, transnational, international, supra-national and supra-national institutions. (Mohamed and Youssef, 2004) [Online]
Multinational Corporation is the business of structural or ownership in the number of countries held or a product into the global decision-making. Standards for transnational corporations have income, assets, a certain percentage of sales or a business form, or in a foreign place of deployment. (Ajami, et. al., 2006) [Online]
To quantify of the typical multinational corporation are regarded as two operating companies in some countries, even though the project required six or more countries in the multinational subsidiary of the Harvard. Another hand that measure the total revenue generated by overseas operations from 25 to 30 percent in the most frequently mentioned. (Mohamed and Youssef, 2004) [Online]
The cost of capital is to determine the conversion of the key variables, save, or invest in resources, these are the decision making on exchange rate. Otherwise, Source of capital is the basis for calculating the weighted cost of capital (WCOC), it is because of the different providers of risk capital factors are demand for firm funds rate may vary depending on suppliers. Most firms have made debt and equity capital of WCOC as part of total capital, those are a reflection of equity and debt or other sources. (Groth and Anderson, 1997) [Online]
The company's management for multinational companies to consider its multinational corporations in management philosophy, the company can be classified as ethnocentric (home-market-oriented), multi-center (on individual foreign market-oriented) and geocentric (oriented to the larger regional and even world status). These will be used worldwide as global multinational companies to some of the domestic business. (Mohamed and Youssef, 2004) [Online]
Factor influencing Multinational Corporation
The following factor are appearing how the debt financing and equity financing improvement to running the business and is it effectiveness the firm to modify the market value, bankruptcy cost and shareholder value.
Dilution of earning per share
In earnings per share of the financing structure are sensitive to change in earnings before interest and tax under different financing options, therefore the two alternative financing plans which issue of debentures and issue of equity share is effective of the percent interest. If the earnings before interest and tax are lower than breakeven level there will be the equity financing more desirable than the debt financing and also increase the business risk in the firm, otherwise when the earnings before interest and tax higher than breakeven level there will opposite holds. (Chandra, 2006)
The large issues of equity as the new investment an immediate could lead to dilution earnings per share of profit therefore the shareholder may upset when stock share prices are leading to failure. (ACCA C5, 2003) [Online]
The cash flow of the financing structure are establishes the debt capacity to investigate the probability of default, whether the management are acceptable probability of default associated on level of debt. Whatever, if the lower probability of default the firm also needs to handle the more debt-intensive on financing structure, this is because the lower probability of default will make the firm has strong and competent management to stable the cash flow. Another hand, the firm is used more equity- intensive will make the firm more profitable to use retained earnings on finance operating. (Chandra, 2006)
When the firm is changing and volatile will effective of the financing structure of operating cash flow. Moreover, the cash balance and operating cash flow are not dependent on external financing to service the debt. Preference in the management of tolerance limit does not reflect a restriction imposed on interest of shareholder, when the management staff can not borrow at all of interest is because probability of default are zero and not effective on interest of shareholder. (Chandra, 2006)
Although the debt is attractive because that cost is cheaper, it will be a disadvantage of pay on interest and capital. If the companies spent high level of borrowing they could not meet the payment of loan interest and principle, therefore those companies will follow to liquidation. (ACCA C5, 2003) [Online] The level of borrowed on the firm are measures the assets invested in business financed by gearing ratio. When the firm using debt decision at the higher gearing ratio with effect the higher risk of business and the bankrupt cost, the opposite of when their using equity decision at the lower gearing ratio also will effect the market value of the firm.
The cost of finance
Debt finance is usually cheaper than equity finance because debt finance more secure by the lenders point of view and pay the interest before dividend. Almost the liquidation of the firm is because debt finance is paid off before equity, therefore the debt is safer investment than the equity and due to the debt investors were lower than the rate of return on equity investors. When the company deductible the tax of debt interest will making the cheaper tax paying in the company unlike the equity share are not deductible tax. (ACCA C5, 2003) [Online]
Debt financing is tending towards large companies with high leverage, low tax rates and high volatility. However, the opportunities level for economic growth is low than will issuers face relatively of high external debt-related financing costs. (Lewis. et. al., 2000)
Comparison of equity financing in making profitable investment opportunities in small companies tend to invest heavily. The issuer at a very high rate of investment compared with the capital, convertible bonds, debt issuance, even if there is adverse selection and insufficient investment in the concerns of investors is likely to be important. (Lewis. et. al., 2000)
The tax shield of the financing structure is allows firm to offset taxable profits to pay interest on the debt, therefore the firm using debt more than equity to made the firm tax saving in the business. The advantage is the use of debt funding to reduce the tax bill and the present value was increase as debt to replace the equity in the capital structure because of the tax shield. (Arnold, 2008)
The firm using more debt to running the business it is because the tax shield cans deductible tax at the firm income statement to saving the tax paying and can lower the tax liability.
The declines of Weighted Average Cost of Capital (WACC) for each unit was increase the debt as the company taxable, but it was argument when takes logical extreme for example as the lowest WACC and the corporate value is highest valid due to the company almost entirely made up by debt. As the cost of equity increase can not completely offset by cheap debt, which is because the overall cost of capital falls throughout the range of gearing. (Arnold, 2008)
Otherwise, the opposite is no-tax on the company analysis was appearing that a advantage of gearing up and reduce cost of debt capital to exactly matched by the disadvantage due to increased risk for equity holders and increase the cost of equity, for those problem will affect company holding the high bankruptcy risk. (Arnold, 2008)
Debt covenants as an agreement between the creditors and a firm in order to agree the condition with the borrowing. The condition agreement between that is for the firm a promise the creditor when the loan are not fully repayment are not legal to apply other short-term loan. Alternatives on the debt covenant provide to use convertible debt when their unable to cover the debt payment.
Convertible debt is issuer face is different from the cost of external finance sources, security deign is an important way to distinguish between the theories. In other words, different external financing problem are accepted to induce distinct security design decisions. (Lewis. et. al., 2000)
According to agency costs of debt security convertible debt provides an important motivation to increase shareholder wealth, these are positive net present value of the project manager of stockholder (debt financing). Otherwise, the equity financing of management is to create discretion to management that their pursuit of goals, such as excessive growth of the firm cost shareholders (equity financing). While convertible debt creates less management discretion than a same size common stock issue, it creates many similar flexibility of direct debt issuer. (Lewis. et. al., 2000) Therefore, a company's objectives are important to decide on debt financing or equity financing. If the firm is looking for higher liquidation or cash flows and in the same time to gain shareholders/debt holders confidence, debt financing would be more favorable. Whereas, the firm will choose for equity financing if its objective is solely focus on maximizing shareholders' benefits.
Ability of assets security
The financing structural as an ability of asset are support to the debt, it is because more stable market value of the lower risk assets will provide the better collateral for debt. Therefore, the firm is allowed to borrowing a larger proportion of such assets market values, for instance as a real estate firm or credit firm generally can support a relatively large amount of leverage. (Emery. et. al., 2007)
Sometimes firm do not take on additional debts, because the risk of insolvency depends not only on the expected debt service coverage, but the firm has the ability to produce by increasing borrowing in order to sale the equity securities and sale of assets in cash. (Emery. et. al., 2007) Even through, if the assets are high risk across with the risk of insolvency, the firm should purpose to keep in the equity rather than the debt issuing.
Nowadays the current existing shareholder are use more debt decision to management the firm, it is because the environment economic society today the interest rate are lower and shareholder are easy to take debt. However the shareholder are cannot to take over debt issue in the firm because it will affect firm taken higher risk of business.
When the firm consider to issue the new financing structure their must focus on generate of cash flows to meet the necessary obligations. (Gitman, 2006) In the firm when their need the stable cash flow to cover periodic interest payments than can take more debt to investment the firm. This is because debt level can be expected to increase with firm multinational given that the increasing international diversification into many less than perfectly related countries should decrease the variability of a company cash flows and lower bankruptcy costs. (Aggarwal and Kyaw, 2009) [Online]
Furthermore, the firm are stated the higher debt ratios therefore it might provide higher cash flow to the firm in order to cover fixed charges under various situation in product, therefore the cash flow is minimized when their increase the financial and foreign exchange market. (Eiteman. et. al., 2004)
The gearing ratio is suitable to issue debt at the lower rate in the firm but need to aim the timing to issuing for example when the gearing ratio are lower in the firm that is the suitable timing to issuing debt because it will more effectiveness to maximize shareholder value and reduce the bankruptcy cost. If the firm continues to issue the equity at the time on lower gearing ratio will become overtaken equity and increase the business risk.
The firm is more prefer to taken the debt of lower interest rate in the tax shield it is because when the firm issuing the debt on the corporate tax it will having the tax-deductible expense as an interest payment. Taken the debt to issue on the firm will be positive way on to deduct the business income tax, lower the liability tax and increase the present value to replace the debt to equity in financing structure. It will help the firm prevent the paying of the tax but the firm must able to recover the loan if not the bankruptcy cost on the firm will increase and may dropping the market value of the firm.
Under the tax law practices when the parent company makes an intra-company loan will considered to permanently invested in the country, if the firm are not considered permanent the debt to invested it will induce the parent company suffering foreign exchange losses on the transactions. (Eiteman. et. al., 2004)
An other hand, the firm suppose to issue the debt financing at the lower interest rate when the earnings per share are higher than the breakeven, it is measure the firm profit should able to recover the debt than only can make decision of debt financing. Therefore the firm is not required to increase the shareholder funds on equity financing, due to those required will effect of the shareholder does not have to bare higher dividend paid. For the existing shareholder also can taken the higher return on the dividend in order the earnings per share are higher. It also can increase the market value of the firm and reduce the bankruptcy cost.
The debt covenant is the agreement when the firm are take more debt in the lower interest rate, therefore their set the condition of those agreement between the firm and the creditor as the debt are clearly cover repayment than can borrowing the new issue of debt. For that condition the creditor does not taken profit on the firm but make sure the loan payment are timely manner therefore can affect the firm in the certain business risk in order to reduce the bankruptcy cost.
All the method of debt financing is that is the advantage on the system of funding can full control the business and their can use the profit to satisfaction the ownership return rate. Furthermore that also can cover the loan payment with taken the additional benefit in taxation. However debt financing is not a secure method but is can ensure the business is solely by the ownership.
The firm high debt operations, in order to encourage more and better performance and in the interests of shareholders, such as owners, managers, entrepreneurs look forward to for the purpose of fiscal expansion. Another hand, debt financing is hitting the point of choice form of entrepreneurship. For the logic of the new share sale to outside investors, the entrepreneur's would undermine control, to successful entrepreneurs in the commercial interest. Therefore, managers will be more inclined to adopt a form of incentive pay, rather than focusing solely to shareholder returns, allowances and leisure. (Arnold, 2008)
Furthermore, the high debt forces of the firm to make regular payments to debt holders, therefore the firm are need the 'spare' cash to managers. Therefore the manager is to keep short-term cash to avoid the shareholder's return for very little thought to the problem of projects. (Arnold, 2008)
If the firm raises significant amounts of new funds to finance growth opportunities, thus may need to borrow more than optimal form the viewpoint of minimizing cost of capital. Those are equivalent to increasing at budget levels of marginal cost of capital. (Eiteman. et. al., 2004)
The agency theory of debt financing recommends dealing with adverse selection by disclosure of private information, credible signaling and third party certification, if disclosure does not leak value-creating information to competition it was lowest cost way of solving the problem. (Chua. et. al., 2009) [Online]
Under the upper part recommendation that using the Modigliani and Miller's theory to supporting those are issue the debt financing, therefore to set out to show what should to happen to the costs of capital when the firm increase or reduce borrowing. (Arnold, 2008)
Modigliani and Miller's theory has created a basic model to making some assumptions that the value of a firm remains constant regardless of the debt level. When the cost of debt increased will raise the costs of equity just enough to leave the weighted average cost of capital, it can affect the value of the firm cash flow from operations. Therefore, the firm can improve the decision making on investment to decide increase the shareholder wealth. (Arnold, 2008)
When the capital market is perfect than Modigliani and Miller's theory will argue, that all the firm will become the same business risk and same annually earnings of the firm expected in the same total value, it is because the net present value of the operation will depend on the value of the firm that is not in the financed. (ACCA C5, 2003) [Online]
This indicates that the use of debt offset by the exact same cheap higher rate of return to shareholders, but a higher return will make up for increased risk of financial leverage. (ACCA C5, 2003) [Online]
The Modigliani and Miller's theory propositions depend on perfect capital markets in the generally well-functioning, however in the world are not have the 100 percent perfect on the 100 percent time, sometimes the Modigliani and Miller's theory also will wrong in the some place. (Chandra, 2006) Modigliani and Miller's theory is to show the company's value does not depend on its capital structure, so when the value of the company more or less depends on the ability of asset value, which will come from the external and internal resources are not related assets. However, that is the advantage for using the debt more than internal funds will be taking more benefit of debt in tax shield tax. (Serrasqueiro and Rogao, 2009) [Online] Another hand the disadvantage is when the firm higher gearing is purpose to increase the equity but the firm still continue to borrowing that will effect the firm become financial leverage and holding the higher bankruptcy cost.
The Modigliani and Miller's theory an additional considers needing the preserve flexibility to maintenance the firm of a significant reserve of unexploited borrowing power. This flexibility means that the company can maintain a reserve borrowing capacity, it can increase the debt capital to deal with unexpected changes, government policies, economic recession or volatility of labor shortages, increased competition, perhaps most importantly, profitable the emergence of investment opportunities. (Chandra, 2006)
The flexibility is a powerful defense against financial distress and its consequences which may include bankruptcy cost are fairly small. However, the loss of flexibility at the firm was liquidity crisis in contrast, it may affect the product's market strategy and business policy, damage the company's value. (Chandra, 2006)
Otherwise, the traditional view most likely the Modigliani and Miller's theory form the tax-adjusted, such as the over gearing range by declines of WACC. However the tax system is benefits from the gearing derive rather than the shareholder are failure to seeking the higher return to respond the financial risk, therefore will more closely the firm are allow for financial distress. (Arnold, 2008)
When the firm taking higher level debt than the financial distress also will following increase and eventually liquidation. The firm are negative effect on a firm value such as the offsets the value of tax relief due to increasing the debt with the higher gearing ratio by the cost are incurring the financial distress. The firm would have seriously damaged when the firm are manages to avoid liquidation of relationships with customer, suppliers, creditor and employees. (Arnold, 2008)
Otherwise suggest using the pecking order theory it is because that can makes the priority and maturity structure of debt. The lower information cost of securities should be issued than only can issued the higher information cost, for those suggested is similarly as the short-term debt should be exhausted than can continue issues long-term debt in the firm. According to pecking order theory of financing of each component should have a dollar deficit projected for the dollars of corporate debt. (Frank and Goyal, 2002) [Online]
Furthermore, the pecking order theory of capital structure is between the uses of the most influential business theories. This is the firm undesirable selection is to prefer internal to external financing, when the external funds are necessary in the firm will prefer debt to equity because the lower information costs related with debt issues and equity is seldom issued. (Frank and Goyal, 2002) [Online]
Otherwise, inside the firm retained earnings are a batter source of funds than is debt and debt is a better deal than equity financing. (Frank and Goyal, 2002) [Online] This means that corporate profits will remain profitable than become less leveraged, and unprofitable companies will be more leveraged lending, therefore to establish a profitability and leverage between observed and presented with profitability is negatively correlated with external financing probability.
Aggarwal (2010) argue that, except for firms at or near the debt capacity under the pecking order theory it will deficit when the new entirely filled with debt issues. Therefore, the firm was expected to finance between the deficit and debt assumption is still lower than the capacity of enterprises, using a positive relationship. (Aggarwal and Kyaw, 2009) [Online]
Costs and benefits may lead to the emergence of a target debt ratio is the second order. The firm financing structure choice is driven by adverse selection, because of information asymmetry arising between the more informed investors, managers and do not quite understand the cost.
The upper part of the analysis of Multinational Corporation should be able to support more debt financing than pure of Domestic Corporations. It has been pointed out several benefits of a Multinational Corporation in the economy than perfectly correlated. This diversification should be translated into lower income volatility, the lower the cost of bankruptcy probability. Therefore, taking into account a debt between Modigliani and Miller theory between the tax shield and the expected bankruptcy cost of the traditional paradigm, Multinational Corporation should have lower expected bankruptcy costs, higher leverage.
Multinational corporations in the international business environment are being considered in determining the objectives of the financing structure of the other factors. If the target company seems to have lower debt ratios, international diversification does not seem to affect low-income fluctuations. Therefore, the idea of multinational companies should be able to carry more debt on the financing structure, because it is able to diversify on national economy not support with less than fully relevant.
However, the gearing ratio also will effect the Multinational corporations it is when the gearing ratio are higher than the firm are still issuing the debt financing, that effectiveness the firm in the higher bankruptcy cost and dropping the market value , if more worse the firm will be collapse in the world. That must properly to consider the firm environment than making decision to take debt financing of investment.
The Modigliani and Miller's theory are stated when the multinational corporations using more debt financing was increase the shareholder return rate and the firm also can get benefit of the tax shield. However when the financial distress are in the firm with the higher gearing ratio and loss of flexibility, it will not issuing debt financing any more. If the firm still wants take debt financing to investment it will affect the firm product's market strategy, business policy and damage the company's value.
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