Está en la página 1de 20

C H A P T E R 17

INTERNATIONAL CAPITAL STRUCTURE


AND THE COST OF CAPITAL
Introduction

• Recently, many major firms throughout the world have begun to internationalize
their capital structure by raising funds from foreign as well as domestic sources.

• Cross-listing of a firm’s shares on foreign stock exchanges is one way a firm


operating in a segmented capital market can lessen the negative effects of a
segmentation and also internationalize the firm’s capital structure.

• By internationalizing its corporate ownership structure, a firm can generally


increase its share price and lower its cost of capital.
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.

• When a firm has both debt and equity in its capital structure, its financing cost can
be represented by the weighted average cost of capital.
K = (1 – λ) Kl + λ(1 – 𝜏 )i
Where:
K = weighted average cost of capital,
Kl = cost of equity capital for a levered firm,
i = before-tax cost of debt capital (i.e., borrowing),
𝜏 = marginal corporate income tax rate, and
λ = debt-to-total-market-value ratio.
Cost of Capital

• Suppose that the firm’s cost of capital can be reduced from under the local capital
structure to under an internationalized capital structure. As the exhibit below
illustrates, the firm can then increase its profitable investment outlay from Il to Ig,
contributing to the firms value.
Cost of capital (%)

Kl

Kg

IRR

0 Il Ig Investment ($)
Exhibit 17.1 The Firm’s Investment Decision and the Cost of Capital
Cost of Capital in Segmented versus Integrated Markets

• The main difficulty in computing the financing cost (K) of a firm is related to the
cost of equity capital (Ke). This return is frequently estimated using the Capital
Asset Pricing Model (CAPM).
𝑅ത = Rf + (𝑅ത M – Rf) βi
Where Rf is the risk-free interest rate and 𝑅ത M is the expected return on the market
portfolio, the market-value-weighted portfolio of all assets. Beta, βi, is a measure of
systematic risk inherent in security i.
Beta is calculated as Cov(Ri,RM)/Var(RM), where Cov(Ri,RM) is the covariance of future
returns between security i and the market portfolio and Var(RM) is the variance of
returns of the market portfolio.
Cost of Capital in Segmented versus Integrated Markets

• In segmented capital markets, the same future cash flows are likely to be priced
differently across countries, as they would be viewed as having different systematic
risks by investors from different countries.

• In integrated international financial markets, the same future cash flows will be
priced in the same way everywhere.

• Investors would require, on average, lower expected returns on securities under


integration than under segmentation because they can diversify risk better under
integration.

• Studies suggest that international financial markets are certainly not segmented
anymore, but still are not fully integrated.
Cost of Capital in Segmented versus Integrated Markets

Example 17.1: A Numerical Illustration

Suppose the domestic U.S. beta of IBM is 1.0, that is, βIBMU.S = 1.0, which is the average beta risk level.
In addition, let us assume that the expected return on the U.S. market portfolio is 12 percent,
that is, 𝑅ത U.S= 12%, and that the risk-free interest rate, which may be proxied by the U.S. Treasury
bill rate, is 6 percent. If U.S. capital markets are segmented from the rest of the world, the
expected return on IBM stock will be determined as follows:
𝑅ത IBM = Rf + (𝑅ത U.S. – Rf) βIBMU.S.
= 6 + (12 - 6) (1.0) = 12%.
Considering the domestic beta risk of IBM, investors would require 12 percent return on their
investment in IBM stock.
Suppose now that U.S. capital markets are integrated with the rest of the world and that the
world beta measure of IBM stock is 0.8, that is, ) βIBMW = 0.8. If we assume that the risk-free rate is 6
percent, that is, Rf = 6% and 𝑅ത W = 12%, we can compute the expected return on IBM stock as follows:
𝑅ത IBM = Rf + (𝑅ത W – Rf) βIBMW
= 6 + (12 - 6) (0.8) = 10.8%
In light of a relatively low world beta measure of 0.8, investors would require a lower return
on IBM stock under integration than they would under segmentation.
Does the Cost of Capital Differ among Countries?

• The cost of capital is likely to vary across countries, due to international differences
in the degree of financial integration, quality of corporate governance,
macroeconomic conditions, and other factors.

• Lau, Ng, and Zhang (2010) report, among other things, that the cost of capital of a
country is strongly related to the home bias in portfolio holdings, which reflects the
country’s degree of financial integration with the rest of the world.

• When a country exhibits a high degree of home bias, as Peru does, the global risk
sharing is hampered, thereby increasing the cost of capital for the country.
Does the Cost of Capital Differ among Countries?

• Based on this finding, Lau et al. suggest that reduced home bias and greater global
risk sharing would help reduce the cost of capital. In addition, they report that
accounting transparency also helps reduce the cost of capital.

• Firms operating in a small, segmented domestic capital market can gain access to
new capital and lower the cost of capital by listing their stocks on large, liquid
capital markets like the New York and London stock Exchanges.
Cross-Border Listings of Stocks

• Generally speaking, a company can benefit from cross-border listings of its shares
in the following ways:
1. The company can expand its potential investor base, which will lead to a higher
stock price and a lower cost of capital.
2. Cross-listing creates a secondary market for the company’s shares, which
facilitates raising new capital in foreign markets.
3. Cross-listing can enhance the liquidity of the company’s stock.
4. Cross-listing enhances the visibility of the company’s name and its products in
foreign marketplaces.
5. Cross-listed shares may used as the “acquisition currency” for taking over foreign
companies.
6. Cross-listing may improve the company’s corporate governance and transparency.
Cross-Border Listings of Stocks

• Despite these potential benefits, not every company seeks overseas listings
because of the costs.
1. It can be costly to meet the disclosure and listing requirements imposed by the
foreign exchange and regulatory authorities.
2. Controlling insiders may find it difficult to continue to derive private benefits once
the company is cross-listed on foreign exchanges.
3. Once a company’s stock is traded in overseas markets, there can be volatility
spillover from those markets.
4. Once a company’s stock is made available to foreigners, they might acquire a
controlling interest and challenge the domestic control of the company.

• In light of the costs and benefits of overseas listings, a foreign listing should be
viewed as an investment project to be undertaken if it is judged to have a positive
net present value (NPV) and thus adds to the firm’s value.
Capital Asset Pricing under Cross-Listings

• International Asset Pricing Model (IAPM) has a few interesting implications.


1. International listing (trading) of assets in otherwise segmented markets directly
integrates international capital markets by making these assets tradable.

2. Firms with non-tradable 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 and higher asset prices, without
incurring any associated costs.
Capital Asset Pricing under Cross-Listings

• The asset pricing model with non-traded assets demonstrates that the benefits
from partial integration of capital markets can be transmitted to the entire
economy through the pricing spillover effect.

• The pricing spillover effect has an important policy implication: To maximize the
benefits from partial integration of capital markets, a country should choose to
internationally cross-list those assets that are most highly correlated with the
domestic market portfolio.
The Effect of Foreign Equity Ownership Restrictions

• While companies have incentives to internationalize their ownership structure to


lower the cost of capital and increase their market values, they may be concerned,
at the same time, with possible loss of corporate control to foreigners.

• Consequently, governments in both developed and developing countries


sometimes impose restrictions on the maximum percentage ownership of local
firms by foreigners.

• Obviously, these restrictions are imposed as a means of ensuring domestic control


of local firms, especially those that are considered strategically important to
national interest.
The Effect of Foreign Equity Ownership Restrictions

Pricing-to-Market Phenomenon
• Suppose that foreigners, if allowed, would like to buy 30 percent of a Korean firm,
but they are constrained to purchase at most 20 percent due to ownership
constraints imposed on foreigners.

• Because the constraint is effective in limiting desired foreign ownership, foreign


and domestic investors may face different market share prices.

• In other words, shares can exhibit a dual pricing or pricing-to-market (PTM)


phenomenon due to legal restrictions imposed on foreigners.
The Effect of Foreign Equity Ownership Restrictions

Example 17.2: A Numerical Illustration

To illustrate the effect of foreign ownership restrictions on the firm's cost of equity capital,
we conduct a numerical simulation using the model economy described in Exhibit 17.
Exhibit 17. provides the standard deviations and correlation matrix of our model economy.
Firms D1 to D4 belong to the domestic country and firms F1 to F4 belong to the foreign country.
For simplicity, the correlation matrix reflects the stylized fact that asset returns are typically
less correlated between countries than within a country; the pairwise correlation is uniformly
assumed to be 0.50 within a country and 0.15 between countries. Both domestic and foreign
investors are assumed to have the same aggregate risk-aversion measure, and the risk-free
rate is assumed to be 9 percent.
The Effect of Foreign Equity Ownership Restrictions

Example 17.2: A Numerical Illustration

Standard
Expected Future Deviation of Share Correlation Matrix
Firm Share Price ($) Price ($) D2 D3 D4 F1 F2 F3 F4
D1 100 16 0.50 0.50 0.50 0.15 0.15 0.15 0.15
D2 100 20 0.50 0.50 0.15 0.15 0.15 0.15
D3 100 24 0.50 0.15 0.15 0.15 0.15
D4 100 28 0.15 0.15 0.15 0.15
F1 100 18 0.50 0.50 0.50
F2 100 22 0.50 0.50
F3 100 26 0.50
F4 100 30

Exhibit 17.2 Description of the Model Economy


The Effect of Foreign Equity Ownership Restrictions

Example 17.2: A Numerical Illustration

Exhibit 17.3 considers the case in which the foreign country imposes a 20 percent ownership
constraint (𝛿 F = 20 percent), whereas the domestic country does not impose any constraint on
foreign investors. In this case, domestic country assets are priced as if the capital markets
were completely integrated. Foreign country assets, however, are priced to market.
In general, the exhibit shows that the firm's cost of capital tends to be higher under the 20
percent ownership constraint than under complete integration. This implies that restricting
foreign equity ownership in a firm will have a negative effect on the firm's cost of equity
capital. For comparison purposes, we again provide the results obtained under complete
segmentation and integration. Specifically, consider foreign firm F1. The exhibit shows that
with 20 percent ownership constraint, the firm's cost of capital is 22.40 percent, which is
computed as a weighted average of the required returns by the domestic and foreign country
investors in F1. Note that in the absence of the restriction, the firm's cost of capital would
have been substantially lower, 19.03 percent. It is also noteworthy that when the PTM
phenomenon prevails, the firm's cost of capital depends on which investors, domestic or
foreign, supply capital. The exhibit also provides the case where both the domestic and
foreign countries impose restrictions at the 20 percent level, that is, 𝛿 D = 20% and 𝛿 F = 20%.
Interpretation of this case is left to readers.
The Effect of Foreign Equity Ownership Restrictions

Example 17.2: A Numerical Illustration

𝜎-constraint
Complete 𝛿 D = 20% Complete
Asset Segmentation 𝛿 F = 20% 𝛿 F = 20% Integration

A. Equilibrium Asset Prices ($)a


D1 81.57 83.04/87.45 85.25 85.25
D2 78.53 80.45/86.22 83.34 83.34
D3 75.30 77.75/85.07 81.41 81.41
D4 71.88 74.86/83.82 79.34 79.34
F1 79.19 86.91/81.12 87.86/80.16 84.01
F2 75.87 85.66/78.31 86.87/77.11 81.99
F3 72.34 84.50/75.38 85.92/73.96 79.94
F4 68.62 83.24/72.28 84.90/70.62 77.76
B. Cost of Equity Capital (%)
D1 22.59 19.15 17.30 17.30
D2 27.34 22.54 19.99 19.99
D3 32.80 26.24 22.84 22.84
D4 39.12 30.46 26.04 26.04
F1 26.28 21.54 22.40 19.03
F2 31.80 25.34 26.48 21.97
F3 38.24 39.96 32.82 25.09
F4 45.73 47.95 38.85 28.60

Exhibit 17.3 International Capital Market Equilibria: The Effect of Foreign Equity Ownership Restrictions
The Financial Structure of Subsidiaries

• One of the problems faced by financial managers of multinational corporations is


how to determine the financial structure of foreign subsidiaries.

• Since the parent company is responsible, legally and/or morally, for its subsidiary’s
financial obligations, it has to decide the subsidiary’s financial structure considering
the latter’s effect on the parent’s overall financial structure.

• The subsidiary, however, should be allowed to take advantage of any favorable


financing opportunities available in the host country, because that is consistent
with the goal of minimizing the overall cost of capital of the parent.

• If necessary, the parent can adjust its own financial structure to bring about the
optimal overall financial structure.

También podría gustarte