Dividend Policy

Dividend Policy

Dividend is the distribution of value to shareholders. Once a company makes a profit, they must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends (Holder et al. 1998). Once the company decides on whether to pay dividends, they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets (Pike and Neale, 2009).  However, the decision made on the dividend has an impact on the company’s position now and in the future. It also impacts on the preferences of investors and potential investors (Holder et al. 1998).

Dividends are usually distributed in the form of cash (cash dividends) or share (share dividends). When a company distributes a cash dividend, it must have sufficient cash to do so, otherwise a firm will have a cash flow problem (Pike and Neale, 2009).  Moreover, profit generated may not be in the form of cash (Pike and Neale, 2009). Therefore, cash flow statement needs to be looked at regularly.  For example, a company may have profit of $500 million but the cash only increase by $200 million in a financial year. This is a concern to the management as insufficient cash may mean the company is unable to pay the dividends or will not be able to invest in the future (Pike and Neale, 2009).   

The tendencies in cash dividend policy are not only influenced by internal factors such as investment opportunity, profitability and liquidity of companies, but also, influenced by external factors such as tax (Jensen & Johnson, 1995; Jensen and Smith, 1984; Lintner, 1956).   Litzenberger and Ramaswamy (1979) highlighted that dividends decrease shareholder wealth.  They argued that investors in high taxation prefer shares will low dividend while investors in low taxation prefer shares that pay high dividends (Litzenberger and Ramaswamy, (1979).

According to Gordon (1959) dividends increase shareholders wealth and due to uncertainty it is preferable to capital gains. In contrast, in irrelevance theory, Modigliani and Miller (MM) (1961) argued that if a company distributed high dividends now it may reduce its dividends in the future.  Their argument based on earnings retention as a better way for financing investment.   As a result, the shareholders may benefit from future investment.  

In the US, Canada, UK, Germany, France, and Japan, the propensity to pay dividends is higher among larger, more profitable firms (Denis and Osoboy ,2008).  These companies’ retained earnings comprise a large fraction of total equity (Denis and Osoboy ,2008).  A research study by Denis and Osoboy (2008) showed that the factors that determinant paying dividends are similar across countries. In all six countries above dividends are affected by firm size, profitability, growth opportunities, and the earned/contributed equity mix (Denis and Osoboy, 2008).  

On the other hand,   Allen et al. (2009) and Cornell and Shapiro (1987) suggest that there are interactions between investment and financing decision.  Cornell and Shapiro (1987) emphasis on non investor stakeholders such as customers, employees, suppliers, distributors and other stakeholders can influence this interaction between the dividend and investment policies. Therefore, non investor stakeholders and capital suppliers have an impact on a firms’ dividend.  

Allen, et al. (2009) highlighted that Interest groups of firms in different society have different influence in corporation decision makings. For example, through a survey, Allen et al. (2009) found that 97 % of Japanese managers, 59 % of German managers, and 60% of French managers addressed   employees’ job security is more important than dividends while only 11% of American managers and 10% of British managers have agreed with this conclusion.  Therefore, to explore each stakeholder’s role in corporate finance is important for corporate finance decision makings around the world.  While the impacts of managers and creditors on dividend policy are well studied, the role of employees in dividend policy across countries remains unrevealed (Allen, et al. 2009).

To sum up, dividend policy is a consequence of interaction between supply and demand of dividends (Allen, et al. 2009).  The dividend policy is determined when this interaction reaches its equilibrium point.  When this equilibrium point is reached, the powers of various interest groups are also balanced. Therefore, to study dividend policy, it is important to explore the interaction among various interest groups and to examine how that interaction affects supply and demand of dividends (Allen, et al. 2009).

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Reference

Allen, F. E., Carletti, R., and Marquez, R. (2009) ‘Stakeholder Capitalism, Corporate Governance and Firm Value, University of Pennsylvania Working Paper No. 09-28

Cornell, B. and Shapiro, A.C. (1987)’Corporate Stakeholders and Corporate Finance’, Financial Management, pp. 5-14.

Denis, D. J. and Osoboy, I. (2008) ‘Why do firms pay dividends? International evidence on the determinants of dividend policy’, Journal of Financial Economics, 89, pp. 62– 82

Holder, M. E., Frederick, W., Langhehr, F.W. and Hexter, J. L. (1998) ‘Dividend policy determinants: An investigation of the influences of stakeholders theory’, Journal of Financial Management, 27 (3) pp. 73 -82

Jensen, G. and Johnson, J. (1995). The dynamics of corporate dividend reductions. Financial Management, 24 (4), pp.31-51.

Jensen, M. C. and Smith, C. W. (1984). The theory of corporate finance: A historical overview. New York, NY: McGraw-Hill.

Lintner, J. (1956) Distribution of incomes of corporations among dividends, retained earnings and taxes. American Economics Review, 46 (2), pp.97-113.

Litzenberger, R. H. and Ramaswamy, K. (1979) ‘The effect of personal taxes and dividends on capital asset prices’, Journal of Financial Economics, 7 (2), pp.163-95.

Miller, M. H. and Modigliani, F. (1961) ‘Dividend Policy, growth and Valuation of shares’, Journal of Business, 34, (4), pp 411- 433.

Bibliography

Juma’h, A.H.  and  Pacheco, C. J. O. (2008) ‘The financial factors influencing cash dividend policy: A sample of U.S. manufacturing Companies

Inter Metro Business Journal, 4, (2) pp. 23-43

The Impact of Risk Assessment and Advanced Investment Appraisal

The responsibility of investment decision is assigned on financial managers.  Therefore, they are responsible for a company’s investment decision, advising on the allocation of funds in terms of the total amount of assets, the composition of fixed and current assets and the consequent risk profile of the choices.  According to Myers (1974) the problem however, lies on the determination of which set of current and planned future transactions will maximize the shareholders' wealth.  This can be employed by, firstly, specifying the firm's objective as a function of investment and financing decisions and secondly, capturing interactions of the financing and investment opportunities by a series of constraints (Myers, 1974).

When evaluating capital budgeting projects, it is important to be able to compare alternatives using an objective yardstick, regardless of the pattern of the cashflows that result from each alternative. However, net present value (NPV) is generally agreed to be the preferred model for evaluating projects (Watson and Head, 2004 ; Myers, 1974 ).  There are other alternative techniques such as the accounting rate of return and the payback / discounted payback methodology. Although not as theoretically sound as NPV, these models nonetheless are still widely-used today, often in conjunction with NPV analysis.

According to finance theory, investment opportunity should be taken as if it already had plenty of cash on hand. In an efficient capital market however, securities can always be sold at a fair price because the net present value of selling securities is always zero.  The cash raised exactly balances the present value of the liability created.  Therefore, the decision rule is: take every positive-NPV project, regardless of whether internal or external funds are used to pay for it (Myers and Majluf,1984).

Additionally, the reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals.  The principal concern for individuals investing in cash equivalents is inflation risk, which is the risk that inflation will outpace and erode returns over time.

According to the Department of Trade and Industry (DTI)  (2006) the search theory can provide a useful framework for analysis of decision making in circumstances where there is uncertainty about the potential costs and benefits of alternative actions.   As a result, the search theory can reduce uncertainty and improve decision making. It is important to remember that investment has important effects on both the demand-side and the supply-side of the economy (Pike and Neale, 2009). On the other hand, The central message of economic theory and the evidence from business surveys is that capital investment is determined by the relationship between the expected returns from investment and the expected cost of financing the investment.

Moreover, the analysis of business decisions about overseas market prioritisation and market-entry strategy can be done in terms of search Models (DTI, 2006).  Watson and Head (2004) However, highlighted that decision makers can be expected to continue to lack perfect information, and to make some poorly informed decisions,  nevertheless having acquired the economically efficient level of information (DTI, 2006) The costs of failure resulting from poorly informed decisions may still be lower than the real resource costs of acquiring additional information (DTI, 2006).

The “options” pricing theory is concern about the understanding of investment behaviour when decision makers face uncertainty about future prices and returns and when their decisions are irreversible (Carruth, et al. 1998).  The key insight is that the  “option” value will the investment decision in order to wait the arrival of new information about market conditions (Carruth, et al. 1998).  As a result, a wedge will be created between the conventional net present value (NPV) calculation of the current worth of an investment project and the current worth of the project to the decision maker. At a given point in time, for an investment to be made, its NPV must be sufficiently larger than zero to cover the value to the decision maker of delaying the decision and keeping the investment option alive. 

Therefore, uncertainty will influence the timing, and hence on the level of investment activity at a given point in time for a particular level of uncertainty prevailing among investors. Moreover, it also points to the possibility of threshold effects, that is, rates of return below which investment will not be undertaken. There are also macroeconomic consequences since such effects can generate real rigidities in the capital accumulation process (Pike and Neale, 2009).

In contrast the work of Hartman (1972) and Abel (1983) suggested that increased uncertainty may raise investment, because of its positive effect on the value of a marginal unit of capital. This result requires that the marginal product of capital (in a competitive firm) is ‘convex in price’ , so that a mean-preserving increase in the variance of price raises the expected return on a marginal unit of capital and therefore raises the attractiveness of investment.

According to Bank of England (2009) there are different of key factors driving capital investment spending.  For example, interest rates, expectations and confidence, profits and external economic factors.  

Reference

Abel, A. B.  (1983) ‘Optimal investment under uncertainty’, American Economic Review, 73,  pp.228-33.

Bank of England (2009 ) Agents’ summary of business conditions

Deparment of Trade and Investment (2006) ‘Rational for Government Support’, International Trade Investment paper No. 18

Hartman, R. (1972) ‘The effects of price and cost uncertainty on investment’, Journal of Economic Theory, 5,  pp. 258-66.

Myers, S. C. (1974) Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting’, The Journal of Finance, 29(1), pp. 1-25.

Myers, S.C. and  Majluf, N, S. (1984) ‘Corporate finance and investment decisions when firms have information that investors don not’,

Journal of Financial Economics 13, pp.187-221.

Pike, R. and Neale, B. (2009) Corporate Finance and Investment: Decisions and Strategies.  6^th edition. Essex: Pearson Education Limited  

Watson, D. and Head, A. (2004) Coporate Finance: Principles and Practice. 3^rd edition. England:Peasrson Education Limited

Carruth, A. Dickerson.A. and Henley, A ( 1998) ‘What do we know about investment under uncertainty?’,

Contemporary International Business Issues: The Credit Crunch of 2008

According to the BBC (2011) credit crunch Defined as "a severe shortage of money or credit."  Clair and Tucker (1993) highlighted that “credit crunch” as a phrase has been used in the past to explain the limitation of the credit supply in response to both, firstly, a decline in the value of bank capital (Beori and Guiso, 2008).  Secondly, conditions imposed by regulators, bank supervisors, or banks themselves that to require banks to hold more capital than they previously would have held (Beori and Guiso, 2008).  It was started in August 2007 and was due to the sub –prime mortgage business when people with poor credit histories were given high – risk loans (BBC New, 2011; Hull and Rotman, 2008).  Therefore, the houses prices fell and subprime mortgage defaults increased (Mizen, 2008).

 Therefore, many of mortgages had been bundled up and sold on to banks and investors (BBC News, 2011). This caused severe financial market instability on the economy and forced banks to write down several hundred billion dollars in bad loan caused by mortgage failure (Brunnermeier, 2009).  As a result, major banks’ stock market capitalization dropped by more than twice (Brunnermeier, 2009).  However, they are still relatively modest compared to the $8 trillion of U.S. stock market wealth lost between October 2007 and October 2008 (Brunnermeier, 2009).    .

The lending boom and housing frenzy were contributed by two trends in the banking industry: First banks moved to an ‘originated and distribute model’ instead of holding loans on banks’ balance sheet, ie. loans were  repackaged and passed on to different investors “ off-loading risk” (Mizen, 2008 ; Brunnermeier, 2009).  Second, short maturity instruments were employed to finance banks’ asset (Mizen, 2008 ; Brunnermeier, 2009) and therefore, banks exposed to a dry-up in funding liquidity (Brunnermeier, 2009). 

The beginning of “Credit Crunch” 

Credit crunch appeared in early 2007 among lower-quality U.S. mortgage lenders.  Sub prime mortgage defaults in February 2007 increased. However, in March it went to its normal level.  In April, a subprime specialist had filed for chapter 11 bankruptcies and this led to employees’ redundancy.  Another example, in early May 2007, the Swiss owned

Investment bank UBS had closed the Dillon Reed hedge fund after incurring $125 million

in subprime mortgage–related losses.  Moreover, in August two European banks, IKB (German) and BNP Paribas (French), closed their hedge funds.  However, closed hedge funds in difficult time developed into the full scale credit crunch of 2007- 2008 and this has increased corporates’ risk. 

According to Mizen (2008) many economists consider the “Great Moderation” in the United States and the “Great Stability” in the United Kingdom contributed to the credit expansion and in turn low inflation and low short term interest rates. For example, Giovanni, et al. (2008) suggest that lending was excessive—what they call “credit booms”- in the past five years. Beori and Guiso (2008) on the other hand, argued that the seeds of the credit booms were introduced by cutting short-term interest rates in response to the 9/11 attacks and the dotcom bubble.   This might be a reasonable reason, but this is unlikely to be the main reason for the expansion of credit (Beori and Guiso, 2008).

Although the euro zone and the United Kingdom, were not as low in crisis as they were in the United States but credit grew there, too (Mizen, 2008).  When U.S. short-term interest rates steadily rose from 2004 to 2006, credit continued to grow (Mizen, 2008).  It is certainly true that the low real short-term interest rates, rising house prices, and stable economic conditions of the Great Moderation created strong incentives for credit growth on the demand and supply side. However, another important driving force of the growth in lending was found in the global savings glut flowing from China, Japan, Germany, and the oil exporters that kept long-term interest rates down, (Mizen, 2008). 

Other countries also increased its debts by the form of credit card borrowing and increased borrowing by offering mortgages as housing markets across the globe increased.   Additionally, borrowers continued to seek funds to increase their housing market share in the future, thinking that he value of the properties and its demand will continue to rise (Mizen, 2008). 

This resulted in mispricing of risk of any high yield asset classes (e.g., hedge funds, private equity, and emerging market equity) (Robert  and Tucker , 1993). Due to the high return of these assets made them attractive to international investors and therefore, the crisis spread internationally and influencing other financial market (Hull and Rotman, 2008).  Sellers of the assets mispriced risks by using models that assumed house prices would continue to rise while interest rate remained low (Mizen, 2008).  

The risk measures used by regulators and financial institutions are largely based on historical experience (Hull and Rotman, 2008).  For example, value at risk measures for market risk is typically based on the movement in market variables seen on the last two to three years (Hull and Rotman, 2008). Moreover, credit risk measures are based on default experience stretching back over 100 years or often the measure is based on the experience on market movement over the last 10, 20 or 30 years( Mizen, 2008 ; Hull and Rotman, 2008).  There is no doubt that historical data can provide a useful guide in measuring but it needs to be supplemented with human judgment (Hull and Rotman, 2008).    

Therefore, underpriced risk with unrealistic assumptions about rising valuations of underlying assets or commodities (Mizen, 2008 ; Hull and Rotman, 2008).  This continued the crisis where banks found it difficult to assess the exposure to subprime and other low quality loans due to complexity of the structured products (Hull and Rotman, 2008).  Banks could not be able to evaluate the losses and this created uncertainty in the interbank market resulted in banks became reluctant to lend to each other unless they were compensated with higher risk premiums (Boeri and Guiso,  2008).

Reference

BBC New (2011) Timeline: Credit crunch to downturn, Available at: http://news .bbc.co.uk/1/hi/7521250.stm, (Access: 3 May 2011)

Brunnermeier, M.K. (2009) ‘ Deciphering the Liquidity and Credit

Crunch 2007–2008’, Journal of Economic Perspectives, 23,(1)pp. 77–100

Boeri, T. and Guiso, L. (2008) “The Subprime Crisis: Greenspan’s Legacy, in Andrew Felton and Carmen Reinhart, eds., The First Global Financial Crisis of the 21st Century, 2008

Robert, C.T. and Tucker, P.  (1993) “Six Causes of the Credit Crunch (Or, Why Is It So Hard to Get a Loan?),” Federal Reserve Bank of Dallas Economic Review, Third Quarter 1993, pp. 1-19

Giovanni, D., Deniz, I.  and  Laeven, L.(2008) “Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market” CEPR Discussion Paper No. 6683, Centre for Economic Policy Research, 2008.

Hull, J.C. and Rotman, J. L. (2008) The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can Be Learned?

Mizen, P. (2008) ‘The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses’, Federal Reserve Bank of St. Louis Review, 90(5), pp. 531-567.

International Business Investment Opportunities: International Merger and Acquisition Activity

Over the past 30 years mergers and acquisition (M&As) as a complex phenomenon has attracted substantial interest from a variety of management disciplines. Merger and acquisition play a vital role in corporate finance and as a source of external growth when organic growth in not possible.  In practice, acquiring another company is a far more complex process. For example, valuing a target company and estimating the potential benefits of acquiring it are more difficult propositions than valuing a simple investment project.  Moreover, the M &A process is often complicated by bids being resisted by the target company and hence acquisition may become a long and unpleasant contest (Weston and Head, 2004).  

Economic Justifications

The economic justification for M &A is that shareholders wealth will be increased by the transaction, as the two companies are worth more combined than as separate companies. This can be shown bellow:

PV           > (PV + PV)

     x+y            x        y         

The PV represents present value and X and Y are the two companies involved. Economic gain may be generated for a number of reasons. For example, synergy, economies of scale, entry of a new markets, market power and market share.

Financial Justifications

Acquisition can also be justified on the grounds of the financial benefits they bring to the shareholders of the companies involved. For example, financial synergy, target undervaluation, tax considerations and increasing earning per share.

Additionally, according to the United Nations New York and Geneva (2005) merger and acquisition can be taken a form of investment into the R&D facility.  It might be argued that such transactions involve a simple change of ownership, similar to portfolio investment, with lesser developmental value.  Some M &A could have an adverse effect.  For example, the acquisition of firms in the automotive and telecommunications industries of Brazil by Transnational corporations (TNCs) in 1990, resulted in a scaling down of R&D activities in the acquired firms (UNCTAD 1999).

Example of Recent Acquisitions

Mergers and acquisitions continue to be a highly popular form of corporate development. For example, in 2004, 30,000 acquisitions were completed globally, equivalent to one transaction every 18 minutes (Cartwright and Schoenberg, 2006).

The total value of these acquisitions was $1,900 billion, exceeding the GDP of several large countries. However, in parallel to these popularity, the failure rates of mergers and acquisitions is high(Cartwright and Schoenberg, 2006).

Recently, according to Guardian (2011) Swiss medical devices maker (Synthes) which makes nails, screws and plates to fix broken bones, as well as artificial spine discs is to be bought by Johnson & Johnson (J&J). The deal worth $21.3bn (£14bn) and it is the largest buy that will boost its orthopedics franchise and reshaping the medical technology industry. However, Target firm shareholders generally enjoy positive short-term returns (Agrawal and Jaffe, 2000), for instance, the diversified healthcare group will pay 159 Swiss francs (£110.38) per share for Synthes and the premium is 8.5% over Synthes's closing share price (Guardian, 2011).  On the other hand, investors in bidding firms frequently experience share price underperformance in the months following acquisition, with negligible overall wealth gains for portfolio holders (Agrawal and Jaffe, 2000).

The deal, which is expected to close in the first half of 2012, has the backing of both boards and will give J&J a leading position in equipment to treat trauma.  Synthes’s sales in 2010 was $3.7bn in 2010. However, Can J&J achieve any real and lasting success? Shareholders record  reveals that acquisitions continue to produce negative average returns similar to those seen historically (Agrawal and Jaffe, 2000; Gregory, 1997). Moreover, target firm executives experience considerable accumulated stress and, on average, almost 70% leave in the five years following completion (Krug and Aguilera, 2005).

Resources

United Nations New York and Geneva (2005) Globalisation of R&D and Developing Countries: Proceedings of the Expert Meeting

UNCTAD (1999). World Investment Report 1999: Foreign Direct Investment and the Challenge for Development. New York and Geneva: United Nations. United Nations publication, Sales No. E.99.II.D.3.

Watson, D. and Head, A. (2004) Corporated Finance: Principles and Practice. 3^rd edition. London: Pearson Education

Johnson & Johnson to buy Synthes for $21.3bn Deal to buy Swiss medical devices maker is J&J's biggest ever- Wednesday 27 April.  Available at: http://www.guardian .co.uk/business/2011/apr/27/johnson-johnson-buy-synthes. (Accessed:  28-4-2011)

Agrawal, A. and J. Jaffe (2000). ‘The post merger performance puzzle’, Advances in Mergers and Acquisitions, 1, pp. 119-156.

Cartwright, S. and Schoenberg, R. (2006) ‘30 Years of mergers and acquisitions Research: Recent Advances and future opportunities’,

British Journal of Management, 17 (1), pp S1-S5.

Krug, J. and R. Aguilera (2005). ‘Top management team turnover in mergers and acquisitions’, Advances in Mergers and Acquisitions, 4, pp. 121-149.

International Business Investment Opportunities: Trends and Theory of Foreign Direct Investment (FDI)

What is Foreign Direct Investment (FDI)

Wild and Han (2004) defined the FDI as the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. Markets can be served by FDI and trade when a firm integrates their operations across borders by trading intermediate goods and services ( Econocmists Advisory Group Ltd ,1996) .

According to Alfaro and Charlton (2007) policy makers often consider foreign direct investment (FDI) as a source of important productivity externalities for the host countries. Additionally, FDI is one source of supplying capital and can be a source of valuable technology and to foster linkages with local firms.  However, despite the strong relation between economic growth and FDI, it is evident that some FDI projects are better than others (Alfaro and Charlton, .2007) while academics treat FDI as a homogenous capital flow (Alfaro and Charlton, 2007).

Economic development in host countries have been driven by FDI as it brings technology, capital, management know-how, jobs and access to new markets.  The benefit that FDI brings to host countries especially to developing countries can be underlined by Policy-makers (OECD-ILO, 2008).  Therefore, government have been set up different policies to attract inward FDI.  It can be argued that although the FDI and multinational enterprises (MNEs) are considered to be beneficial for local development, however, there are social concerns about their presence in host countries (OECD-ILO, 2008). For example, multinational enterprise (MNEs) have often been accused of taking unfair advantage of low wages and weak labour standards in developing countries where there is a weak union. MNEs also have been accused of violating human and labour rights in countries where governments fail to enforce such rights effectively.

According to Alfaro, and Charlton (2007) a complex measure implementation has been set up in Dublin to Beijing to accept or refuse FDI projects. As a result, the value of inward investment must be judged on its nature and quality rather than in quantitative measures or job numbers alone (IDA, 2008).

.

FDI Motives and Locations

Corporate have many motives for expanding abroad including sourcing low cost factors, avoiding taxes, managerial rent-seeking, and behaving strategically by following competitors (Chung and Alcacer ,2000).

While others conduct foreign direct investment (FDI) when they possess unique capabilities to be sold to foreign firms (Chung and Alcacer, 2000).

If these companies are not able to do so, then the firm will expand abroad to gain the highest returns - the capabilities are “internalised”.  Recently, the major motive is that, firms expand abroad to search for new capabilities. This motive has been termed “asset seeking” and “reverse internalisation”( Chung and Alcacer, 2000).

National policies in the host country, however, try to find ways to attract some types of FDI and regulate other types.  This is resulted in FDI projects can differ greatly in terms of the national benefits to be derived from them (Alfaro and Charlton, 2007).  For example, the UNCTAD’s World Investment Report (2006) defined “quality FDI” as “the kind that would significantly increase employment, enhance skills and boost the competitiveness of local enterprises.”  

As a result of the inflow of managerial resources, the FDI makes a vital contribution to productivity growth of the host country.  However, the FDI has a negative impact on reduction in employment at domestic firms in response to competition from foreign multinational.  Empirical studies highlighted that foreign firms are more productive and profitable than domestic firms and can make a significant contribution to overall growth (Alfaro and Charlton, 2007).  For example, FDI in Ireland increased by 14% with a total of 130 new investments (Ireland’s Industrial Development Agency, (IDA), 2008) and this created 8,837 new jobs in 2008 (IDA, 2008).

The Importance of FDI for Developing Countries

There was a rise in FDI in 2007 reflected relatively high economic growths and strong economic performance in many parts of the world (United Nation, 2008)  As a result, this increases corporate profits and in turns provided funds to finance investment and reduced the impact of decreasing loans from the banks affected by the sub-prime credit crisis(United Nation, 2008).   Around $1,100 billion profit in 2007 which contributed to higher reinvested and about 30% of total FDI flows in 2007.  These profits was generated in developing countries rather than in developed countries (United Nation, 2008).

Reference

Alfaro, L. and Charlton, A. (2007) Growth and the quality of foreign direct investment: Is All FDI Equal

Chung, W. C. and Alcacer, J. (2000) Heterogeneous Investment Motives and Location Choice of Foreign Direct Investment in the United States (September, 2000). NYU Stern School Working Paper.

Economists Advisory Group Ltd (1996)The Single Market Review Series: Summary Impact on trade and investment.FOREIGN DIRECT INVESTMENT

Summary

IDA  Annual Report 2008. [online] Available at: http://www.idaireland .eu/news-media/press-releases/ida-annual-report-2008/ (Accessed: 20/ 4 /2011)

OECD-ILO (2008) Conference on corporate social responsibility: Employment and industrial relations: promoting Responsive Business Conduct in Globalising Economy

UNCTAD, 2006. World Investment Report: FDI from Development and Transition Economies: Implications for Development. United Nations, New York.

United Nation (2008) World investment Report: Transnational Corporations, and the Infrastructure Challenge. United Nation Conference on Trade and Development (UNCTAD)

Transfer Pricing and Off-shore Tax Haven Usage

Public service depends heavily on taxes but there is a contradiction in western legislation toward tax havens for more than a century that affects both rich and poor nations alike(Shah, (2009).   Individual and companies have to pay taxes.  However, by employing creative solicitors and accountants, some multinational companies and wealthiest people afford to escape paying taxes (Shah,(2009).  

Companies such as Enron, Newscorp, Elan, Exxon, Northern & Shell Group, Portland Investment, Microsoft, General Motors and others have used tax havens to reduce or eliminate their tax bills.   As a result, in the 2002 the UK government lost extra revenue of £85 billion.  If it was collected, it would have been funded schools, hospitals, pensions, public transport and social infrastructure.  

The UK government is unable to tackle this problem, claiming that there is insufficient fund to invest in public service (Mitchell et al. 2002).  However, the government could tax billions of pounds that escape in offshore tax havens by adopt a progressive taxation policies and tax the rich more.  As stated by the United Nations (1998)

 “The common denominator in money-laundering and a variety of financial crimes is the enabling machinery that has been created in the financial havens and offshore centres”.

Why would companies avoid paying taxes?  Tax avoidance is one way in which companies have been utilising to maximise shareholders funds.  Therefore, multinational companies are placed to exploit tax havens and hide the true profits.  For example, According to Mathiason (2007) Jersey has increasingly been used by Swiss bankers to help their clients avoid the withholding tax levied on Swiss corporate dividends.  Around $78bn of so-called Swiss fiduciary deposits were moved from their banks to Jersey.

Reference

Shah, A. (2009) Tax Avoidance. Available at: http://www.globalissues. org/article /54/tax-havens-undermining-democracy. (Accessed:13 April 2011

United Nations Office for Drug Control and Crime Prevention, (1998)

Financial Havens, Banking Secrecy and Money Laundering, Vienna, United Nations.

Mathiason, N. (2007) Jersey is $491bn tax haven: 4 November 2007  Availabel at: http://www.guardian.co.uk/business/2007/nov/04/4tory (Accessed:  15 April 2011)

Mitchell, A., Sikka, P., Christensen, J., Morris, P. and Filling, S. (2002)

No Accounting for Tax Havens:  Shedding light on darker practices Working for an Open and Democratic Society

The Foundation of Raising Finance for Multinational Enterprises Collaborative and Foreign Subsidiaries

Debt: is very different from equity finance.  Debt is money borrowed which must be repaid at a set time period and generates income for the lender over that time period. Lending sources include not only banks, but also leasing companies, factoring companies and even individuals.

Lending sources look primarily at two factors: how risky the loan is; and whether the company can generate sufficient cash to pay the interest and repay the principal. The growth potential of the company is secondary; the primary considerations are the track record and asset base of the company. Usually the debt must be secured against the assets of the company and very commonly must also be secured against the assets of the owner of the company, also called a personal guarantee.

The lender often requests that the personal assets of the owner of the company are pledged as a contingency and as a gesture of faith by the owner. Obviously, if the owner of the company does not believe in his/her own company's ability to repay the loan, why should the lending source?

Equity: Equity capital is money given for a share of ownership of the company. Equity can be provided by individual investors, sometimes known as "angels", venture capital companies, joint venture partners, and the sweat equity and capital contribution of the founders of the company.  Equity providers are more interested in the growth potential of the company.

Since the objectives of investors are different from lenders, the factors they evaluate in determining whether to invest are different from lending sources. Investors like to put money in companies that have the potential for rapid growth. Growth potential is based on the quality of management of the company, product brand strength, barriers of entry to competitors and size of the market for the product.

The significance rise in trade volume of both equity and debt investments play an important role in driving the growth of economy.  The increasing trade openness among countries is allowing the world equity markets to integrate financially with the world capital markets.  Stock markets across the world are becoming larger both in volumes and sizes and the world economy is getting more liquidity.

Though the equity returns are more volatile in comparing to debt returns. Equity markets aim at long term growth support to both public and private enterprises consisting of both high risks and high returns.

In current economic crisis, world global equity market fell to 47% in 2008, it is around $32 trillion.  Global mergers and acquisition (M and A) volumes declined by 30 % (source IFL equity research, 2009).  

Debt markets like equity markets play a major role in growth and development of the economy, especially for the developing nations or third world countries. Debt allows government, businesses, and individuals to continue to trade nationally and internationally.  In modern financial markets, debts markets have been more institutional and play a major contributor in growing up the economy.  This can be through both purchasing and issuing the debts instruments. However, too much debt leads the economy to bankruptcy. Debts are often termed as mutual elements of inflations or deflations that can cause destabilizing the price level.

Investors cannot ignore the risk involved in choosing financing course. The option between equity and debts should be analysed and high returns involves greater risk, and the greater the risk the greater the possibility of loss and vice versa. 

Currently, financing project abroad is a high risk especially in the Middle East. The situation in Libya is continued to worsen.  Moreover, spread the political demonstrations in eastern Saudi Arabia might affect oil price.  The oil price rose by 4 % in the last week. 

Marketers think that the oil alarm will be temporary.  However, the Middle Eastern political direction will be changed in the future, and therefore, the oil prices might change according to the political internal and external policy of a particular country.  The countries in which depends completely on Middle East’s oil need to take this into consideration and create a contingency plan to minimize the risk involved.

Libyan oil production is already down by two thirds.  This is a bad news for Italy and Ireland, each of which imports nearly a quarter of its needs from Libya.  The US crude broke the $100 barrier and Brent briefly topped $110 a barrel.  It can be seen from Libyan’s conflict that the oil prices could double from current levels if the political crisis continues through the region.