MBA 713 - Chapter 03

Editor's Notes

• #2: The goal of this chapter and the next one is to understand the impact of the various dimensions of a country’s environment on the management of a firm’s international business. This chapter discusses the legal, technological, accounting, and political dimensions, while Chapter 4 focuses on the cultural dimensions.
• #3: This chapter’s learning objectives include the following:Describing the major types of legal systems confronting international businesses. Explaining how domestic laws affect the ability of firms to conduct international business. Listing the ways firms can resolve international business disputes.
• #4: Additional learning objectives include:Describing the impact of the host country’s technological environment on international business.Identifying the factors that influence national accounting systems.Explaining how firms can protect themselves from political risk.
• #5: A domestic firm must follow the laws and customs of its home country. An international business faces a more complex task: It must obey the laws not only of its home country but also the laws of all the host countries in which it operates. Both home and host country laws affect the way international firms conduct their business. These laws determine the markets those firms may serve, the prices they can charge for their goods, and the cost of necessary inputs such as labor, raw materials, and technology. The laws may also affect the location of economic activity.
• #6: National legal systems vary dramatically for historical, cultural, political, and religious reasons. International businesspeople must be aware of these differences in legal systems to avoid costly misunderstandings. Common law is the foundation of the legal systems in the United Kingdom and its former colonies. It is based on the cumulative wisdom of judges’ decisions through history. Laws that affect business practices vary among these countries. In addition to evolutionary differences in case law, statutory lawsenacted by legislative action also vary among the common law countries. Civil law is based on a codification, or detailed listing, of what is and is not permissible. In a common law system, the judge serves as a neutral referee, ruling on various motions by the opposing parties’ lawyers. In a civil law system, the judge takes on many of the tasks of the lawyers.Religious law is based on the officially established rules governing the faith and practice of a particular religion. A country that applies religious law to civil and criminal conduct is called a theocracy.The legal system in communist countries and in dictatorships is often described as bureaucratic law. The law is whatever the country’s bureaucrats say it is, regardless of the formal law of the land. Contracts can be made or broken at the whim of those in power.
• #7: This section presented The Legal Environment of globalbusiness. The next section will cover How Domestic Laws Affect the Ability of Firms to Conduct International Business.
• #8: The laws of the countries in which an international business operates play a major role in shaping the opportunities available to that firm.
• #9: Some of these laws are primarily designed to regulate the domestic economic environment. Such laws affect all facets of a firm’s domestic operations: managing its workforce, financing its operations, marketing its products, and developing and utilizing technology. Although such laws are primarily focused on the domestic marketplace, they may indirectly affect the ability of domestic firms to compete internationally by increasing their costs, thus reducing their price competitiveness relative to foreign firms.Domestically oriented laws may also inadvertently affect the business practices of foreign firms operating outside the country’s borders. If a firm’s products are geared to the export market, it may alter production techniques to meet the regulations of the importing countries, even though its operations are legal within its home country.
• #10: Some national laws are designed to regulate international business activities. Such laws are often politically motivated and designed to promote the country’s foreign policy or military objectives. A country may attempt to induce a second country to change an undesirable policy by imposing sanctions against commerce with that country; such as restricting access to high-technology goods, withdrawing preferential tariff treatment, boycotting the country’s goods, and denying new loans.An embargo is a comprehensive sanction against all commerce with a given country. An embargo may be enforced by countries acting in unison or alone. Countries may also attempt to regulate business activities that are conducted outside their borders, a practice known as extraterritoriality. For example, firms may be vulnerable to antitrust lawsuits if they engage in activities outside of a country’s borders that diminish competition in that country’s market.
• #11: On other occasions countries may pass laws that are explicitly directed against foreign-owned firms. Ownership issues are a particular area of concern. Often when leftist governments obtain power, they choose to transfer ownership of resources from the private to the public sector, a process known as nationalization. Most vulnerable to such actions are industries that lack mobility: natural resource industries such as crude oil production and mining, and capital-intensive industries such as steel and chemicals. When the host government compensates the private owners for their losses, the transfer is called expropriation. When the host government offers no compensation, the transfer is called confiscation. The conversion of state-owned property to privately owned property is called privatization. It creates opportunities for international businesses to expand their operations into key sectors of a national economy, such as telecommunications, transportation, and manufacturing. However, many governments limit foreign ownership of domestic firms to avoid having their key industries controlled by foreigners. Countries can also constrain foreign MNCs by imposing restrictions on their ability to repatriate (return to their home countries) the profits earned in the host country.
• #12: Multinational Corporations (MNCs) that establish operations beyond the borders of their home country affect the political, economic, social, and cultural environments of the host countries in which the firms operate. Many effects are positive such as direct investments in new plants and factories; tax revenues that support educational, transportation, and other municipal services; and technology transfers. On the other hand, MNCs may also have negative effects on the local economy. If MNCs compete directly with local firms, those firms may lose both jobs and profits. Furthermore, if an MNC announces layoffs, cutbacks, or a shutdown of local operations, the effects can be devastating to a local economy.The political impact of MNCs can be significant. Their sheer size often gives them tremendous power in each country in which they operate. Furthermore, there is always the possibility that this power will be misused.MNCs influence the cultures in which they operate. As they raise local standards of living and introduce new products and services, people in the host cultures develop new norms, standards, and behaviors. Many of the changes (such as safer equipment or better healthcare) are positive; however, if locals are not trained how to use the new products or services properly, some of the changes will not have a positive outcome.
• #13: This section covered the following elements that explain How Domestic Laws Affect the Ability of Firms to Conduct International Business: domestically oriented laws and laws that directly affect international business, laws directed against foreign firms, and the impacts of MNCs on host countries.The next section will cover Dispute Resolution in International Business.
• #14: Resolving disputes in international commerce can be complicated. The complexities range from determining the laws that apply to the situation and where the issue should be resolved to selecting the methods of resolving the issue and enforcing the settlement.
• #15: Typically, four questions must be answered in order to resolve an international dispute:Which country’s law applies?In which country should the issue be resolved?Which technique should be used to resolve the conflict: litigation, arbitration, mediation, or negotiation?How will the settlement be enforced?Many international business contracts specify answers to these questions to reduce the uncertainty and expense associated with resolving disputes. The courts of most major trading countries will honor and enforce the provisions of these contracts, as long as they do not violate other aspects of the country’s public policy.
• #16: If a contract does not specify applicable laws and where disputes will be resolved, each party to the transaction may seek to have the case heard in the court system most favorable to its own interests. This process is known as forum shopping.Whether a foreign court order will be enforced is determined by the principle of comity, which provides that a country will honor and enforce the judgments and decisions of foreign courts. For the principle to apply, countries must agree to honor each other’s court decisions, defendants must be given proper notice, and foreign court judgments must not violate domestic statutes or treaty obligations. Many international businesses seek less expensive means of settling disputes over international transactions. Arbitration is a common technique for settling disputes. During the arbitration process, both parties to a conflict agree to submit their cases to a private individual or committee whose decision they will honor. Because of the speed, privacy, and informality of such proceedings, disputes can often be resolved more cheaply than through the court system.
• #17: This section covered Dispute Resolution in International Business by presenting four questions that must be answered before a dispute can be resolved and by reviewing international business contracts.The next section will cover The Technological Environment as it pertains to international business.
• #18: Another important dimension of a country is its technological environment. The foundation of that environment is its resource base—for example, fertile agricultural land, natural resources, and labor. The availability or unavailability of resources will affect what products are made in a given country.
• #19: Countries may change or shape their technological environments through investments. Many countries have invested heavily in their infrastructures—highways, communications systems, waterworks, and so forth—to make producing and distributing products easier. Similarly, many countries have invested heavily in human capital. By improving the knowledge and skills of their citizens, countries improve the productivity and efficiency of their workforces. Investments in infrastructure and human capital have allowed developed countries to continue prospering in world markets, despite high wages paid to workers in those countries.Technology transfer is another means of altering a country’s technological environment. It involves the transmittal of technology from one country to another. Some countries have promoted technology transfer by encouraging foreign direct investment (FDI). Other countries have improved their technological base by requiring companies eager to access a country’s resources or consumers to transfer technology as a condition for operating in that country.
• #20: An important determinant of a country’s technological environment—and the willingness of foreign firms to transfer technology to the country—is the degree of protection that its laws offer to intellectual property rights. Intellectual property (patents, copyrights, trademarks, and brand names) is an important asset of most Multinational Corporations. It often forms the basis of a firm’s core competency or competitive advantage in the global marketplace. The value of intellectual property can quickly be damaged unless countries enforce ownership rights of firms. Countries that provide weak protection for intellectual property are less likely to attract technology-intensive foreign investments. Weak intellectual property protection also discourages local firms from developing intellectual property.Most countries have passed laws protecting intellectual property rights; international treaties also protect these rights. However, not all countries have signed the treaties, and enforcement of these treaties is often lax. Furthermore, international conflicts can develop because of inconsistencies in intellectual property laws, as well as differences in patent practices and protection for trademarks and brands.
• #21: This section explored The Technological Environment as it pertains to changing or shaping technological environmentsand protectingintellectual property rights. The next section will cover The Accounting Environment of international business.
• #22: An business must develop and maintain an accounting system that provides the internal information needed by managers to run the firm and the external information needed by shareholders, lenders, investors, and government officials in all the countries where the firm operates. Differences in the policies and procedures of national accounting systems can create significant operational and control problems for an any business that operates in international markets.
• #23: A country’s accounting standards and practices reflect the influence of legal, cultural, political, and economic factors. Because these factors vary by country, the underlying goals and philosophy of national accounting systems also vary dramatically. These factors affect how firms report income and profits, value inventories and assets, report taxes, use accounting reserves, and do business in other countries.
• #24: International businesses that rely on foreign accounting records but don’t recognize national accounting differences can make expensive strategic errors and operating mistakes. Most countries’ accounting systems assume that an asset is carried on the firm’s books according to its original cost, less depreciation. Because of inflation, however, the market value of an asset is often higher than its historical cost. The resolution of this problem differs among national accounting systems.The two methods for valuing inventories are LIFO (last in, first out) and FIFO (first in, first out). There are international differences in the use of the two methods. When comparing two firms, it is important to know how inventories are valued. In Germany, accounting procedures are detailed explicitly in the German Commercial Code and German tax laws. No distinction is made between financial statements for shareholders and financial statements for German tax authorities. U.S. firms report two different sets of financial statements—one to the Internal Revenue Service (IRS) and one to shareholders. Another difference in national accounting systems involves the use of accounting reserves to record future expenses. The use of accounting reserves by U.S. firms is carefully monitored and limited by the Internal Revenue Service (IRS) because charges to them reduce a firm’s taxable income. In contrast, the German Commercial Code permits German firms to establish accounting reserves for various potential future expenses. Because these reserves reduce reported income on which taxes are based, most German firms use them aggressively.
• #25: Many other differences exist in how countries treat accounting issues. The following are a few examples:Capitalization of financial leases:U.S., British, and Canadian firms must capitalize financial leases, whereas Swiss firms are not required to do so.Capitalization of research and development (R&D) costs:Most countries permit firms to capitalize R&D expenses, but this practice is forbidden in the United States, except in limited circumstances.Treatment of goodwill:A firm that acquires a second firm often pays more than the book value of the acquired firm’s stock. The excess payment is called goodwill. The firm can write off goodwill immediately or capitalize it and then amortize it over a period of time.
• #26: The national differences in accounting practices would be little more than a curiosity were it not for the need for information to make international business decisions. Comparing the financial reports of firms from different countries is exceedingly complex, making it more difficult for international investors to assess the performance of the world’s businesses.These differences can affect the global capital market in other ways. For example, the New York Stock Exchange (NYSE) is concerned about SEC-mandated accounting rules that must be followed by publicly traded corporations. Those rules emphasize full and comprehensive disclosure of financial performance information. The NYSE fears that the rules discourage foreign firms from listing on the exchange, thereby threatening the exchange’s global competitiveness. The SEC disclosure requirements for U.S. firms do offer certain advantages, however. Those policies result in reliable numbers for assessing the riskiness of potential loans, not only for domestic sources of capital but also for international sources.
• #27: This section has explored the following elements involved in The Accounting Environment of international business: the roots of national differences, differences in accounting practices, and the impact on capital markets. The next section will cover The Political Environment of international business.
• #28: An important part of any business decision is assessing the political environment in which a firm operates. Laws and regulations passed by any level of government can affect the viability of a firm’s operations in the host country. Political turmoil and expropriation of a firm’s property are equally dangerous to the viability of a firm’s foreign operations.
• #29: Most firms are comfortable assessing the political climates in their home countries. However, assessing the political climates in other countries is far more problematic. Experienced international businesses engage in political risk assessment, a systematic analysis of the political risks they face in foreign countries. Political risks are any changes in the political environment that may adversely affect the value of a firm’s business activities. Most political risks can be divided into three categories:Ownership risk occurs when the property of a firm is threatened through confiscation or expropriation.Operating risk occurs if the safety of a firm’s employees or its ongoing operations are threatened through changes in laws, tax codes, terrorism, and so forth.Transfer risk occurs when the government interferes with a firm’s ability to shift funds into and out of the country.
• #30: Political risks may result from governmental actions, such as passage of laws that expropriate private property, raise operating costs, devalue the currency, or constrain the repatriation of profits. Nongovernmental actions, such as kidnappings, extortion, and acts of terrorism are also elements of political risk. A macropolitical risk affects all firms in a country. A micropolitical risk affects only a specific firm or firms within a specific industry.
• #31: Any firm contemplating a new-market entry should acquire basic knowledge of that country, by answering questions such as the following: Is the country a democracy or a dictatorship? Does the country normally rely on the free market or on government controls to allocate resources? Are the firm’s customers and competitors in the public or private sector? When making changes in its policies, does the government act arbitrarily or does it rely on the rule of law? How stable is the existing government? Most MNCs continually monitor the countries in which they do business for changes in political risk. The type and amount of information a firm needs to assess political risk will depend on the nature of its business and how long it is likely to be in the host country.
• #32: Some degree of political risk exists in every country. In political risk assessment, as in most business decisions, it is a matter of balancing risks and rewards.To reduce the risk of foreign operations, most developed countries have created government-owned or government-sponsored organizations to insure firms against political risks. For instance, the Overseas Private Investment Corporation (OPIC) insures U.S. overseas investments against nationalization, insurrections or revolutions, and foreign-exchange inconvertibility. The Multilateral Investment Guarantee Agency (MIGA), a subsidiary of the world bank, provides similar insurance against political risks. Private insurance firms, such as Lloyd’s of London, also underwrite political risk insurance.
• #33: This section has explored the following elements of The Political Environment of international business: understandingpolitical risk, assessing political risk, and reducing risks associated with foreign operations. This concludes our discussion of Legal, Technological, Accounting, and Political Environments. The presentation will close with a review of this chapter’s learning objectives.
• #34: This concludes the PowerPoint presentation on Chapter 3, “Legal, Technological, Accounting, and Political Environments.” During this presentation, we have accomplished the following learning objectives: Described the major types of legal systems confronting international businesses. Explained how domestic laws affect the ability of firms to conduct international business. Listed the ways firms can resolve international business disputes. Described the impact of the host country’s technological environment on international business.Identified the factors that influence national accounting systems.Explained how firms can protect themselves from political risk.For more information about these topics, refer to Chapter 3 in International Business.