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Why MNC's exist

Comparative Advantage (CA) theory: Extension of Adam Smith's 'absolute advantage' theory (countries combines specialisation to increase pareto-optimal solution - improve welfare).

David Ricardo founder of CA theory (similar principles) - Countries export goods/services it produces more efficiently than others and imports goods other countries produce more efficiently. Consequently, brings the need for international trade (hence, why MNC's exist). 

However, doesn't say all countries benefit, says countries 'can' benefit. Also, when there has been increased restrictions on international trade (such as in 1930's), overall welfare has declined. 

Imperfect market theory: Factors of production aren't freely mobile due to market imperfections. In some cases, MNCs create such imperfections through intangible capital. MNC's exist to exploit these imperfections, and produce wealth that would otherwise not have been created. EU is an example of a restricted market.

Product life cycle theory: MNC's seek to enter new markets over time to capitalise on perceived advantages, i.e., initially accommodate local demand then export products to accommodate foreign demand then establish foreign subsidiaires. Most MNCs have adopted this approach. 

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Goal of MNC's and Agency problems

Commonly accepted goal - maximise shareholder wealth

Divorce of ownership and control brings rise to agency problem as management may behave in manner that conflict with proprietors interest 

MNC's experience more agency costs than domestic firms - potential problems conflicting with MNC goal:

Locate subsidiary in a location that manager favors 

Decision to expand may be fueled by managers interests (eg. bonus for excessive risk) 

Mangers may be concerned maximising their utility, e.g., may ignore positive NPV projects if too perceived as too much work  or if companies in financial distress

Different cultures may not follow uniform goals

Non-UK managers downplay short term consequence of decisions 

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Agency Problems continued

There will always be the perception that shareholders interests can be more vigorously pursued.

Centralised structure can reduce agency problems as Financial Mangers (of parent) have direct control over SBUs, reducing power of SBUs managers but parent managers may make bad decisions for SBUs.

Decentralised structure can increase agency costs as subsidiary managers may not act in interest but SBU managers have a better understanding of local environments.

Given trade-off's, some MNCs attempt to achieve advantages of both (decentralised with high monitoring).

Internet facilitates management control making it easier to monitor, e.g., Parent of Jersey plc uses internet to trace inventory, sales, expenses and earnings of foreign sub's - thus reducing agency costs of international businesses

Other forms of corporate control to reduce agency costs: Stock options

Threat of hostile takeover or firing managers

Investor monitoring - shareholder activism 

Bank montiroing and debt contracts - issue debt instead of equity capital as banks access info better

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