1、International Capital Structure and the Cost of Capital,Chapter Seventeen,Chapter Outline,Cost of Capital Cost of Capital in Segmented vs. Integrated Markets Does the Cost of Capital Differ Among Countries? Cross-Border Listings of Stocks Capital Asset Pricing Under Cross-Listings The Effect of Fore
2、ign Equity Ownership Restrictions The Financial Structure of Subsidiaries,Cost of Capital,The cost of capital is the minimum rate of return an investment project must generate in order to pay its financing costs. For a levered firm, the financing costs can be represented by the weighted average cost
3、 of capital: K = (1 )Kl + (1 t)i,Where K = weighted average cost of capital = debt to total market value ratio Kl = cost of equity capital for a levered firm t = marginal corporate income tax rate i = pretax cost of debt,The Firms Investment Decision and the Cost of Capital,A firm that can reduce it
4、s cost of capital will increase the profitable capital expenditures that the firm can take on and increase the wealth of the shareholders. Internationalizing the firms cost of capital is one such policy.,cost of capital (%),Investment ($),Cost of Capital in Segmented vs. Integrated Markets,The cost
5、of equity capital (Ke) of a firm is the expected return on the firms stock that investors require. This return is frequently estimated using the Capital Asset Pricing Model (CAPM):,If capital markets are segmented, then investors can only invest domestically. This means that the market portfolio (M)
6、 in the CAPM formula would be the domestic portfolio instead of the world portfolio. Clearly integration or segmentation of international financial markets has major implications for determining the cost of capital.,Cost of Capital in Segmented vs. Integrated Markets,versus,Does the Cost of Capital
7、Differ Among Countries?,There do appear to be differences in the cost of capital in different countries. When markets are imperfect, international financing can lower the firms cost of capital. One way to achieve this is to internationalize the firms ownership structure.,Does the Cost of Capital Dif
8、fer Among Countries?,Cross-Border Listings of Stocks,Cross-border listings of stocks have become quite popular among major corporations. The largest contingent of foreign stocks are listed on the London Stock Exchange. U.S. exchanges attracted the next largest contingent of foreign stocks.,Cross-Bor
9、der Listings of Stocks,Cross-border listings of stocks benefit a company: The company can expand its potential investor base, which will lead to a higher stock price and lower cost of capital. Cross-listing creates a secondary market for the companys shares, which facilitates raising new capital in
10、foreign markets. Cross-listing can enhance the liquidity of the companys stock. Cross-listing enhances the visibility of the companys name and its products in foreign marketplaces.,Cross-Border Listings of Stocks,Cross-border listings of stocks do carry costs: It can be costly to meet the disclosure
11、 and listing requirements imposed by the foreign exchange and regulatory authorities. Controlling insiders may find it difficult to continue to derive private benefits once the company is cross-listed on foreign exchanges. Once a companys stock is traded in overseas markets, there can be volatility
12、spillover from these markets. Once a companys stock is made available to foreigners, they might acquire a controlling interest and challenge the domestic control of the company.,Cross-Border Listings of Stocks,On average, cross-border listings of stocks appears to be a profitable decision The benefi
13、ts outweigh the costs.,Some Foreign Firms Listed on the NYSE,Some Foreign Firms Listed on the NYSE,Capital Asset Pricing Under Cross-Listings,Recall the definition of beta:,We can recalibrate the CAPM formula:,As:,Capital Asset Pricing Under Cross-Listings,We can develop a measure of aggregate risk
14、aversion, AM,We can restate the CAPM using AM,Capital Asset Pricing Under Cross-Listings,This equation indicates that, given investors aggregate risk-aversion measure, the expected rate of return on an asset increases as the assets covariance with the market portfolio increases. In fully integrated
15、capital markets, each asset will be priced according to the world systematic risk.,Capital Asset Pricing Under Cross-Listings,The International Asset Pricing Model (IAPM) above has a number of implications. International listing of assets in otherwise segmented markets directly integrates internatio
16、nal capital markets by making these assets tradable. Firms with nontradable assets essentially get a free ride from firms with tradable assets in the sense that the former indirectly benefit from international integration in terms of a lower cost of capital.,The Effect of Foreign Equity Ownership Re
17、strictions,While companies have incentives to internationalize their ownership structure to lower the cost of capital and increase market share, they may be concerned with the possible loss of corporate control to foreigners. In some countries, there are legal restrictions on the percentage of a fir
18、m that foreigners can own. These restrictions are imposed as a means of ensuring domestic control of local firms.,Historical Restrictions on Foreign Ownership,Pricing-to-Market Phenomenon,Suppose foreigners, if allowed, would like to buy 30 percent of a Korean firm. But because of ownership constrai
19、nts imposed on foreigners, they can purchase at most 20 percent. Because this constraint is effective in limiting desired foreign ownership, foreign and domestic investors many face different market share prices. This dual pricing is the pricing-to-market phenomenon.,Asset Pricing under Foreign Owne
20、rship Restrictions,An interesting outcome is that the firms cost of capital depends on which investors, domestic or foreign, supply capital. The implication is that a firm can reduce its cost of capital by internationalizing its ownership structure.,An Example of Foreign Ownership Restrictions: Nest
21、l,Nestl used to issue two different classes of common stock: bearer shares and registered shares. Foreigners were only allowed to buy bearer shares. Swiss citizens could buy registered shares. The bearer stock was more expensive. On November 18, 1988, Nestl lifted restrictions imposed on foreigners,
22、 allowing them to hold registered shares as well as bearer shares.,Nestls Foreign Ownership Restrictions,Source: Financial Times, November 26, 1988 p.1. Adapted with permission.,SF,An Example of Foreign Ownership Restrictions: Nestl,Following this, the price spread between the two types of shares na
23、rrowed dramatically. This implies that there was a major transfer of wealth from foreign shareholders to Swiss shareholders. The price of bearer shares declined about 25 percent. The price of registered shares rose by about 35 percent. Because registered shares represented about two-thirds of the ma
24、rket capitalization, the total value of Nestl increased substantially when it internationalized its ownership structure. Nestls cost of capital therefore declined.,An Example of Foreign Ownership Restrictions: Nestl,Foreigners holding Nestl bearer shares were exposed to political risk in a country t
25、hat is widely viewed as a haven from such risk. The Nestl episode illustrates: The importance of considering market imperfections. The peril of political risk. The benefits to the firm of internationalizing its ownership structure.,The Financial Structure of Subsidiaries,There are three different ap
26、proaches to determining a subsidiarys financial structure: Conform to the parent companys norm. Conform to the local norm of the country where the subsidiary operates. Vary judiciously to capitalize on opportunities to lower taxes, reduce financing costs and risk, and take advantage of various market imperfections. In addition to taxes, political risk should be given due consideration in the choice of a subsidiarys financial structure.,
