Vocabulary

1. Define foreign portfolio investment. How does it differ from foreign direct
investment?
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2. Foreign direct investment decisions are normally based on clear business strategies.
Name at least three categories that companies are looking for.
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3. Give some examples of investment incentives. What are they supposed to achieve?
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4. What is non-exclusive distributor called? What does this mean?

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5. What are royalty payments?

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 6. Define joint venture.
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FOREIGN DIRECT INVESTMENT
The decision to invest outside the home country is a major one that requires careful
analysis. Investments overseas can be portfolio investments, where investors buy shares
and debentures (long-term obligations) that can be liquidated at market value any time.
These investments can be made without leaving the home country through an international
investment broker or a banking institution. Foreign direct investments are quite different.
They usually involve the establishment of plants or distribution networks abroad. Investors
may acquire part or all of the equity of an exciting foreign company with the objective of
controlling or sharing control over production, research and development, and sales.
Contrary to portfolio investments, foreign direct investments mean a long-term
commitment where capital funds will be tied up for a long time.
Multinational corporation usually take a strategic approach is to locate or create
markets for its present and future products. Markets for products are no longer national in
today’s world. The technological and cultural changes of the twentieth century and
particularly in the three decades after World War II, have created fairly uniform world
markets, with increasingly similar economic and social needs. All countries in the world
strive to full technological growth and the highest possible standard of living, regardless of
their present stage of development. Consequently, MNCs of all types and nationalities,
large and small, have expanded with great vitality abroad, often overshadowing their
market shares at home. Such is the case, for example, of the Swiss drug companies and the
leading German, Japanese, and American automobile manufacturers.
The typical MNC pools all its resources to achieve the highest possible efficiency and
obtain the maximum return on investments. Research and development, raw materials,
investment capital, and managerial skills are utilized for the benefit of many world markets.
For examples, an automobile originally designed in Japan is later sold, assembled or
manufactured, with minor changes, in the United States, Canada, Brazil, Western Europe,
and so on. The basis development costs, like research and design, can be expected to be
amortized on sales in many markets. Research may be carried out in one country, parts
made in another, then assembled and sold in a third country.
 Most American multinationals, already technologically advanced, do not have to
invest overseas to seek “know-how”. Many European and Japanese companies, however,
come to the United States to do just that. Their primary aim is to benefit from American
technology. For example, The British company, Plessey, made a $190 million bid to take
over American Alloys Unlimited, before the bid. Plessey believed that it would be less
costly to pay a higher price for technical “know-how” than to do research and development
in the alloy field over a period of time.
Financial considerations are also the most important and sometimes decisive factors.
What is the expected return on an investment? What are the sources of working capital?
What are interest rates? What is the cash flow projection? – i.e. the amount of cash that
remains after a company has paid taxes and other cash expenses? Only when reliable access
to outside financing is available can a project for foreign direct investment be termed
viable. A non-viable project is one where the expected rate of return, or profits realized on
assets employed, is likely to be lower than from a comparable investment in the host
country.
Local regulations or legislation is another factor that must be studied before an
investment is made. When Thomson, the French electronics group, set up a company to
produce military electronic devices in Chicago, it found out about the Buy American Act
only after the acquisition. This act prohibits the United States government form purchasing
foreign-made military equipment with the exception of components. Subsequently,
Thomson withdrew from the company at a substantial loss. United States antitrust
legislation prohibits corporations from dominating or monopolizing an industry. When
British Oxygen bought 35 percent of Airco, a major United States producer of industrial
gases, it was sued by the US federal government for violating antitrust laws. Labor laws
are still another important legislative factor. Before an investment is made, it is important
to consider right-to-work laws and the existence of absence of labor unions.
The likelihood of government interference has to be studied. Despite France’s efforts
to attract foreign investment in the past companies to divest themselves of their French
subsidiaries. In 1976 International Telephone and Telegraph (ITT) sold its interest in Le
Matériel Téléphonique (producer of telephone equipment) to Thomson, a French company,
as a result of government pressure.
Investment incentives are still another consideration. These incentives are usually of a
monetary nature, such as cash grants, lower taxes, accelerated depreciation, training
allowances, research subsidiaries, and interest rebates on loans. Incentives differ from
country to country and region to region and are always highest in a depressed area. In
Belgium, where many coal mines have shut down, certain regions experienced long periods
of unemployment. These regions are likely to offer incentives to foreign investors.
Prior to making a foreign investment, a corporation has usually had some form of trade
with the foreign nation. When a corporation starts to export for the first time, it will usually
engage distributors, who receive a commission on products sold. Distributors are called
exclusive if they are under contract to sell only the exporter’s products. Otherwise, they are
called multiple, representing other manufacturers as well.
When the foreign country becomes familiar with the products, the company might not
renew the contract with the distributors but rather will set up its own sales organization. It will
acquire its own network of dealers throughout the country, probably supervised by various
regional sales offices. Again, dealers can be exclusive or multiple.
Building up a dealer network is complicated and expensive. The exporter may prefer
to license a foreign manufacturer. The later is then authorized to manufacture the product
under license, using the original manufacturer’s brand name. In return, the exporter will
receive royalty payments. A drawback of licensing, as well as of authorizing foreign
distribution, is that the original manufacturer gives up control over the product. If the
licensed product lacks quality, the exporter’s reputation will suffer. It may be very difficult
to correct a distributor’s marketing mistakes if the exporter eventually decided to handle
the distribution.
Therefore, licensing and distributing are almost always of a temporary nature. Sooner
or later the exporter will be faced with the foreign direct investment question. The basis
decision is whether to set up a manufacturing plant or make an acquisition of an existing
one. Then there is the question of whether to create a joint venture or go it alone. A joint
venture is a subsidiary formed by two or more corporations. This form is chosen when
companies want to share capital outlay and “know-how”. In the long run, it is often an
unsatisfactory relationship, as the respective partners find it increasingly difficult to share
control. However, in some countries, such as Japan and Spain, a foreign investor cannot
own more than 50 percent of a corporation; that is, local interests in the foreign venture
must equal at least 50 percent.
In many countries, especially in parts of the Third World, there is resistance to foreign
direct consequence of criticism of multinational corporations. In the industrialized nations,
such as France and the United States, opposition is also growing. Even in some quarters in
the United States, foreign investment is seen as a threat. The critics forget, however, that
their countrymen invested six times as much overseas in 1976 as did foreigners in the
United States.
 Some strategic industries (such as food, computers, nuclear reactors, and energy) will
find it increasingly difficult to expand abroad. Foreign investment will be dependent on the
power struggle between governments and multinational corporations. But direct
investment is likely to continue its adventurous course in many areas. The economic
integration of the United States, Europe, and Japan will stimulate its development.

Reading comprehension tasks

1. When foreign direst investors acquire a company, what do they normally seek to
control?
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2. In considering foreign investment, what is an MNC’s first strategic objective?
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3. What are some financial considerations in making a foreign direct investment?

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4. When is a foreign project said to be viable? What is a nonviable project?
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5. Name two kinds of legislation that foreign investors study closely prior to making
an investment?
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6. Why are investment incentives highest in a depressed area?
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7. When a corporation starts to export for the first time, how will it organize its sales?
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8. What is a drawback of licensing or authorizing foreign distribution?
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9. If a company does not want complete manufacturing responsibility for a foreign
market, what ownership possibility remains?
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D. Exercises
Exercise 1: Fill in the blanks in the sentences below with the correct word or
phrase.
1. When investors establish a plant overseas, this is called ………………… If they
buy shares or long-term debt obligations, this is called ……………
2. The amount of cash that remains after a company has paid taxes and other cash
expenses is ……………….
3. Rate of return is often measured in terms of profits realized on …………
4. A cash grant is called an ……………., whose purpose is to ………..
5. Prior to making a foreign direct investment, exporters can make a contract with a
……………. or with a foreign manufacturer, who will be ……………. to
manufacture their products. For this, the foreign manufacturer pays
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Exercise 2: Complete this passage by using the word in italics.
attitude equity incentives investors levels prosperity
dominate employ train set up bring out
Countries in the Third World have different approaches to foreign investment. Some
welcome foreign firms, encouraging them to (1)…………………… subsidiaries by
offering them tax (2)………………. or cheap loans. These countries believe that the
foreign firms will provide jobs, pay good wages, (3)…………………. local workers,
bring new technology, and contribute to their (4)……………….
Other countries have a different (5)………………… to foreign investment. They know
that they need the multinationals, but they do not want these firms (6)…………………
important sectors of their economies. Therefore, they (7)……………….. laws which
force foreign companies to sell shares to local (8)……………….. They insist that local
businessmen own a certain percentage of the foreign firm’s (9)………………. Some
governments also make the foreign firm (10)………………. a certain percentage of
local workers at all (11)……………… in the company.
Exercise 3: Find an appropriate word for each blank space. In all sections the
initial letter of each word is provided.
a) Most multinational companies are vast enterprises with networks of (1)
s………………… or (2) a……………… throughout the world. Originally, they
expanded overseas because trade barriers such as (3) t……………… and (4)
q…………… had been set up against their goods.
b) When incomes are rising and business is thriving, in other words, when there is an
(5) e………………. (6) b…………….. in a country, a multinational may decide to
establish a subsidiary there. Later, however, the government of the country may only
allow the company to operate on a (7) j………………. (8) v…………….. basis, in
which case it will compel the company to reduce its (9) s………………. to a fixed
percentage. It could even restrict the subsidiary by allowing only a fixed proportion of
profits to be (10)r……………….
 c) The OECD code gave (11) g……………….. on how multinationals should behave.
None of its provisions were (12)l………………. (13) e……………… and therefore
some say it lacked legal teeth.
d) A factory whose production resources are not being fully utilized is said to be
suffered from (14) o………………
Exercise 4: Picture yourself as a corporation president who is about to decide on
making a foreign direct investment. What questions would you ask yourself?
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