Multinational Corporations and Multinational Banks

NB: We do not resell your papers. Upon ordering, we do an original paper exclusively for you.

NB: All your data is kept safe from the public.

Table of Contents

Introduction
Multinational Companies and Banks
Agency Issues in Multinational Banks
Difference of Agency Issues between Domestic and Multinational Banks
Conclusion
References

Introduction

The purpose of this essay will be to discuss the agency issues that are occur in multinational banks and how these agency issues differ from those of domestic banks. Agency issues refer to the conflicts of interest that usually arise between the shareholders and managers of a company. These conflicts usually occur because of the different interests represented by both groups which bring about an agency cost problem. The theory that is commonly used to explain agency problems within organizations is referred to as the agency theory. The theory explains the various aspects of agency issues such as why companies make bad acquisitions that are detrimental to the financial management of a company, the aspect of capital structure and the selling of company stock in the public market (Emery et al 2004).

Agency issues or problems are a common occurrence in many organizations especially publicly listed companies that are trading in the financial markets. These conflicts always arise as a result of the differing opinions between shareholders and managers of a company when it comes to running the operations of the company. For example an agency issue might arise when a company decides to invest in a business venture that the shareholders of a company might view to be too risky financially.

Because risky business strategies increase the risk of debt, shareholders can be able to benefit from the investment only if it yields higher returns than the initial investment. However in the event the risky business strategy fails, the shareholders will share in a significant way in the losses that have been incurred by the company. Agency issues are therefore constant problems that a company has to deal with especially when exploring new business investments (Brigham and Daves 2010).

Multinational Companies and Banks

This study seeks to determine the agency issues that are related to multinational companies with particular focus on multinational banks. Multinational companies are described as those companies that have business operations in more than one country. These companies manage the production of goods and services in more than one country and they employ a large number of employees to conduct the various business operations of the company.

These companies have been termed by many financial experts to be the distinctive feature of today’s globalized economy as they contribute to a large portion of the world’s financial markets. Some multinational companies in the world have large budgets that exceed the gross domestic product of most countries in the world which means that they have a powerful influence in the local and international economies of countries around the world. Multinational corporations (MNC) conduct their business with the main aim of maximizing the shareholder wealth of the company’s stakeholders (Pitelis and Sugden 2000).

Multinational banks have an equal influence on the globalized economy with most banks operating in more than 100 countries. These banks have an equal impact on the economy of the countries where they have established their operations which means that they are important instruments in the financial growth of a country (Barba and Giorgio 2004). Some of the well known multinational banks in the world include Citigroup which operates 16,000 offices in over 140 different countries.

Citigroup boasts of an employee base of 200 million customers while the second most known multinational bank, HSBC, boasts of having 128 million customers spread over 86 countries around the world. Multinational banks are some of the most profitable companies in the world and their growing influence in the financial markets of the world demonstrate their stronghold on investment and financial matters. A surprising fact that has arisen in the research of multinational companies is that most studies which have focused on the rapid growth of multinational banking over the last few years have been unable to provide any useful evidence that can be used to prove that the growth of multinational corporations is profitable for a company in the domestic front (Focarelli and Pozzolo 2005).

Studies that have been conducted on multinational companies have revealed that while domestic and cross-border financial expansions have been viewed to be beneficial for most companies in terms of the real economy, there has been weak and unsupportive evidence that explains the scope of the economies of scale and also the shareholder value of these financial diversifications (Hauswald and Bruno 2009). According to Cornett et al (2003), the limited number of studies that have been conducted on whether shareholder value is affected by cross-border expansions has still not been addressed adequately by most researchers in the field.

The debate has however continued on the costs and benefits that most multinational company’s direct towards diversification activities. The arguments have mostly been based on a theoretical point of view with most researchers arguing that cross-border diversification activities can enhance the value of a company where they increase the market share and market power of the company in its country of operation (Correia 2009).

This increased market share enables these countries to efficiently utilise their physical and human resources for optimum results that will ensure the company continues to stay in business across the border (Amihud et al 2002). However, diversification might also diminish market share in the event the shareholders of the company view the diversification exercise to be too risky. This gives rise to an agency issue or problem for the company that in turn creates agency costs that will be needed to deal with the conflicts between the shareholders and managers of a company (Martin and Sayrak 2003).

Agency Issues in Multinational Banks

Just like all companies, multinational banks experience agency issues as a result of conflicts of interest that arise between the investors, shareholders and managers of the bank. To deal with these conflicts, companies usually spend financial resources and funds to ensure that the conflicts have been properly addressed. The cost that is usually spent to deal with agency issues is referred to as agency costs and these costs are usually higher for multinational corporations when compared to those that are incurred by domestic companies.

The reasons for this are that a lot of costs are needed to monitor and evaluate managers and chief executive officers who are operating across the border and also the employee numbers of multinational corporations are larger than those of domestic companies which means that more money needs to be spent to manage any conflicts of interest that might arise within the organization (Stiroh and Rumble 2006).

Multinational banks just like multinational corporations are driven by the main goal of diversification and expansion across the border and this might create an agency issue with the shareholders of the company who might have a problem with the large amounts of money that are needed by multinational corporations to invest in cross-border business ventures (Acharya et al 2006). An increase of the MNC’s market value and share power usually comes at the expense of the company’s customers, clients, investors and shareholders where their investments are used in the expansion activities of the company.

Such a situation leads to agency problems or issues that have a negative impact on the allocation of company resources which are needed to enhance the cross-border diversification activities of the multinational corporation. Most of the agency problems that arise in multinational corporations are similar to those that occur in domestic companies where a conflict of interest between the executives of the MNC and the corporation’s shareholders leads to an agency problem (Lamont and Polk 2002). To understand the genesis of these conflicts of interest, the agency relationships that exist in multinational corporations need to be discussed.

With regards to financial management, the agency relationships that exist in most corporations are the relationships between the stockholders and managers of a company and the agency relationships that exist between the stockholders and debt holders of a company. In such companies the shareholder’s wealth maximization might be overlooked as managers of the company strive to achieve their own personal goals rather than those of the company. Many multinational banks are operated by chief executive officers who are focused on maximizing the profitability of the company at the expense of the shareholder (Baker and Powell 2005).

As mentioned earlier, most multinational banks focus all their resources on the diversification of their businesses to international borders which at times impacts on the shareholder in a positive or negative way. When multinational banks engage in the cross-selling of financial products to international customers abroad, they create agency problems with their shareholders in the domestic market who might not gain shareholder values from their activities.

Most studies have revealed that managers are usually driven by the personal need to expand and maximize the size of their companies because of the benefits that come with company maximization. The benefits that accrue from maximization include job security where managers are assured of working for the organization in the event a hostile takeover occurs or the company is involved in a merger or acquisition. Managers who take part in diversification activities also increase their personal power and status both within the company and also in the eyes of investors. They are also assured of a higher salary and bonuses when they engage in company expansion activities as compensation in companies is usually directly correlated to the size of the organization (Brigham and Daves 2010).

Agency conflicts under such management usually arise when the managers of a company decide to pursue company diversification without considering the effect that these expansion activities will have on the shareholders of a company. The company’s shareholders might object to the wealth maximization activities that the company wants to undertake which in turn creates an agency problem. If these problems remain unresolved, the shareholders might decide to withdraw their investments in the form of company stock and invest them elsewhere lowering the common stock held by the company.

To respond to this, the company’s managers are forced to lower the price of their company stock so that more investors and shareholders can be able to invest in the company. The low stock prices in turn affect the financial returns on investment by the company which impacts on the overall profitability of the company (Schmid and Walter 2009).

To avoid such a scenario, the shareholders of a company are usually forced by circumstances to incur agency costs so that they can encourage managers on how to maximize the company’s long-term stock prices. Agency costs cover three aspects which include the expenditures for monitoring managerial actions, structuring the activities of organizations and opportunity costs that are incurred by shareholder-restrictions when it comes to limiting the maximization activities of the company’s managers.

Since managers are in the best position to manipulate information in the financial market, good incentives and compensation plans that are based on improving the stock prices of the company become good options to ensure their wealth maximization plans are dealt with. If the shareholders of a company fail to take any action on the behaviour of managers, they will incur a significant loss through their shareholder wealth as a result of managerial greed. Agency issues therefore have to be dealt with to ensure such a scenario does not happen (Fabozzi and Drake 2009).

Difference of Agency Issues between Domestic and Multinational Banks

The agency issues that occur in multinational banks are similar to those that occur in domestic banks as with all other companies that have investments from shareholders and other important stakeholders. However, there are several differences that exist between the agency conflicts that occur in domestic and multinational banks. To begin with, the agency costs that will be incurred by the multinational banks so as to effectively deal with agency conflicts will be much higher when compared to those of the domestic banks.

The high agency costs are attributed to the large number of managers, chief executive officers and employees who work for the multinational corporation which means that additional funds will be required to monitor the activities of the bank’s managers (Alessandrini et al 2009). Because profitability plays an important role in the diversification activities of most multinational corporations, agency problems will more than likely arise in trying to reconcile investment and commercial banking activities.

Investment banking for both domestic and multinational banks plays a pivotal role in the diversification activities of the bank but it creates an agency problem for multinational banks when managers try to incorporate investment banking into the commercial banking activities of the organization. Such reconciliation will lead to a decrease in shareholder value and the stock price of the company as the bank tries to manage a portfolio of various commercial investments (Focarelli and Pozzolo 2008).

Domestic banks are more focused on meeting the banking needs of the local market and also addressing shareholder investment issues to ensure that stockholders can be able to gain a return on their investment. Domestic banks that diversify their operations from within their country of operation do not have to incur diversification discounts which are usually transferred to the shareholders of the multinational bank (Villalonga 2004).

The economies of scale for multinational banks when compared to those of domestically operated banks are lower because of the increasing optimal size of the bank. As diversification involves increasing the number of human and financial resources, the additional costs needed to meet this increase in optimal bank size are always transferred to the shareholders of the company who might not be on board with the bank’s diversification activities. This creates an agency issue or conflict of interest for the bank where shareholders withdraw their stock from the bank (Amel et al 2004).

According to Laeven and Levine (2007), financial conglomerates or multinational banks that engaged in a lot of financial activities across borders had a smaller stock price when compared to domestic banks that had less diversification. The authors attributed this to the many financial costs that were needed to manage the international companies and also ensure that the expansion activities do not in any way interfere with the financial performance of the bank in the stock market (Lelyveld and Knot 2009). However, other researchers such as Baele et al (2007) noted that multinational banks had a strong positive relationship between the share price of the bank’s stock options and the income/balance sheet diversification costs that arise from increased lending activities by the bank.

Conclusion

This study has focused on the agency issues or conflicts that occur in multinational corporations with particular focus on multinational banks. The findings offered a definition for agency issues and also the types of agency relationships that exist within many companies around the world. The term multinational organizations and banks were also defined and the agency issues that arise in multinational conglomerate banks were identified and discussed. Since the investment activities of domestic and multinational banks are different, the agency issues that affect these banks are also different. The discussion therefore identified the contrasting aspects of agency issues between the two financial institutions.

References

Acharya, V.V., Hasan, I. And Saunders, A., (2006) Should banks be diversified? evidence from individual bank loan portfolios. Journal of Business, Vol.79, No.3, pp 1355-1412.

Alessandrini, P., Presbitero, A.F., and Zazzaro, A., (2009) Banks, distances and firms financing constraints. Review of Finance, Vol.13, No.2, pp 261-307.

Amel, D., Barnes, C., Panetta, F., and Salleo, C., (2004) Consolidation and efficiency in the financial sector: a review of the international evidence. Journal of Banking and Finance, Vol.28, No.10, pp 605-617.

Amihud, Y., DeLong, G., and Saunders, A., (2002) The effects of cross-border bank mergers on bank risk and value. Journal of International Money and Finance, Vol.21, No.6, pp 857-877.

Baele, L., Jonghe, O.D., and Vennet, R.V., (2007) Does the stock market value bank diversification? Journal of Banking and Finance, Vol.31, No.7, pp 1999-2023.

Baker, H.K., and Powell, G.E., (2005) Understanding financial management: a practical guide. Oxford, UK: Blackwell Publishing.

Barba, N.G, and Venables, A., (2004) Multinational firms in the world economy. New York: Princeton University Press.

Brigham, E.F., and Daves, P.R, (2010) Intermediate financial management. Mason, Ohio: Cengage Learning.

Cornett, M.M., Hovakimian, G., Palia, D., and Tehranian, H., (2003) The impact of the manager-shareholder conflict on acquiring bank returns. Journal of Banking and Finance, Vol.27, No.1, pp 103-131.

Correia, R., (2009) Cross-border bank acquisitions: is there performance effect? Journal of Financial Services Research, Vol. 32, No.2, pp 169-197.

Emery, D.R., Finnerty, J.D., and Stowe, J.D., (2004) Corporate financial management. New Jersey; Prentice Hall.

Fabozzi, F.J., and Drake, P.P., (2009) Finance: capital markets, financial management, and investment management. New Jersey: Hoboken.

Focarelli, D., and Pozzolo, A.F., (2005) Where do banks expand abroad? An empirical analysis, Journal of Business. Vol. 78, No.6, pp 2435-2463.

Focarelli, D., and Pozzolo, A.F., (2008) Cross-border M and A’s in the financial sector: is banking different from insurance? Journal of Banking and Finance, Vol.32, No.1, pp 15-29.

Hauswald, R.H., and Bruno, V.G., (2009) The real effect of foreign banks. Paolo, Brazil: Paolo Baffi Centre Research Paper No. 2009-50.

Laeven, L., and Levine, R., (2007) Is there a diversification discount in financial conglomerates? Journal of Financial Economics, Vol.85, No.2, pp 331-367.

Lamont, O., and Polk, C.A., (2002) Does diversification destroy value? evidence from industry shocks, Journal of Financial Economics, Vol.52, No.1, pp 83-110.

Lelyveld, I., and Knot, K., (2009) Do financial conglomerates create or destroy value? evidence for the EU. Journal of Banking and Finance, Vol.33, No.12, pp 2312-2321.

Martin, J.D., and Sayrak, A., (2003) Corporate diversification and shareholder value: a survey of recent literature. Journal of Corporate Finance, Vol.9, No.1, pp 37-57.

Pitelis, C., and Sugden, R., (2000) The nature of the transnational firm. New York: Routledge.

Schmid, M.M., and Walter, I., (2009) Do financial conglomerates create or destroy economic value? Journal of Financial Intermediation, Vol. 18, No.2, pp 193-216.

Stiroh, K.J., and Rumble, A., (2006) The dark side of diversification: the case of US financial holding companies. Journal of Banking and Finance, Vol.30, No.8, pp 2131-2161.

Villalonga, B., (2004) Does diversification cause the diversification discount? Financial Management, Vol.33, No.2, pp 5-27.

Click Here To Order Now!