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Finance Function in a Global
Corporation

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108 Harvard Business Review
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by Mihir A. Desai

HISTORICALLY, the finance functions in large U.S. and European firms have focused on cost control, operating budgets, and internal auditing. But as corporations go global, a world of finance opens up within them, presenting new opportunities and challenges for CFOs. Rather than simply make aggregate capital-structure and dividend decisions, for example, they also have to wrestle with the capital structure and profit repatriation policies of their companies’ subsidiaries. Capital budgeting decisions and valuation must reflect not only divisional differences but also the complications introduced by currency, tax, and country risks. Incentive systems need to measure and reward managers operating in various economic and financial settings. The existence of what amounts to internal markets for capital gives global corporations a powerful mechanism for arbitrage across national financial markets. But in managing their

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John Hersey

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FINANCE & ACCOUNTING

internal markets to create a competitive advantage, finance executives must delicately balance the financial opportunities they offer with the strategic opportunities and challenges presented by operating in multiple institutional environments, each of which has it own legal regime and political risks. There is also a critical managerial component: What looks like savvy financial management can ruin individual and organizational motivation. As we’ll see in the following pages, some of the financial opportunities available to global firms are affected by institutional and managerial forces in three critical functions: financing, risk management, and capital budgeting.

Financing in the Internal Capital Market
Institutional differences across a company’s operations allow plenty of scope for creating value through wise financing decisions. Because interest is typically deductible, a CFO can significantly reduce a group’s overall tax bill by borrowing disproportionately in countries with high tax rates and lending the excess cash to operations in countries with lower rates. CFOs can also exploit tax differences by carefully timing and sizing the flows of profits from subsidiaries to the parent. However, tax is not the only relevant variable: Disparities in creditors’ rights around the world result in differences in borrowing costs. As a consequence, many global firms borrow in certain foreign jurisdictions or at home and then lend to their subsidiaries.

Multinational firms can also exploit their internal capital markets in order to gain a competitive advantage in countries when financing for local firms becomes very expensive. When the Far East experienced a currency crisis in the 1990s, for example, and companies in the region were struggling to raise capital, a number of U.S. and European multinationals decided to increase financing to their local subsidiaries. This move allowed them to win both market share and political capital with local governments, who interpreted the increased financing as a gesture of solidarity. But the global CFO needs to be aware of the downside of getting strategic about financing in these ways. Saddling the managers of subsidiaries with debt can cloud their profit performance, affecting how they are perceived within the larger organization and thereby limiting their professional opportunities. Similar considerations should temper companies’ policies about the repatriation of profits. For U.S. companies, tax incentives dictate lumpy and irregular profit transfers to the parent. But many firms choose to maintain smooth flows of profits from subsidiaries to the parent because the requirement to disgorge cash makes it harder for managers to inflate their performance through fancy accounting. Finally, letting managers rely too much on easy financing from home saps their autonomy and spirit of enterprise, which is why many firms require subsidiaries to borrow locally, often at disadvantageous rates.

Managing Risk Globally
The existence of an internal capital market also broadens a firm’s risk-management options. For example, instead of managing all currency exposures through the financial market, global firms can offset natural currency exposures through their worldwide operations. Let’s say a European subsidiary purchases local components and sells a finished product to the Japanese market. Such operations create a long position in the yen or a short position in the euro. That is, those operations will become stronger if the yen appreciates and weaker if the euro appreciates. This exposure could be managed, in part, by offsetting exposures elsewhere in the group or by having the parent borrow in yen so that movements in the yen asset would be cancelled by movements in the yen liability.

The finance function must locate decision making at a geographic level where other strategic decisions are made.
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The company’s subsequent attempts to improve its capitalGiven this potential for minimizing risk, it might seem investment decision process illustrate the organizational perverse that many multinationals let local subsidiaries and challenges CFOs face as they move from domestic to foreign regions manage their risks separately. General Motors is a markets. In order to improve the quality of valuations, AES case in point. Even though its treasury function is widely required managers to incorporate sovereign spreads into regarded as one of the strongest pools of talent within the their discount rates. Sovereign spreads measure the differcompany – and one of the best corporate treasury functions ence between the rates at which two countries can borrow in worldwide – GM’s hedging policy requires each geographic the same currency, and they are widely tacked on to discount region to hedge its exposures independently, thereby vitiating rates in order to adjust for country risk. the benefits of a strong, centralized treaAlthough this method created the semsury. Why duplicate so many hedging blance of tremendous precision, it came decisions? Because forcing a business’s with some curious incentives, particuhedging decisions to correspond to its larly for managers charged with securgeographic footprint gives GM moreing deals in emerging markets. Knowing accurate measurements of the perforthat their projects would face very high mance of the individual business unit discount rates, managers forecasted and of the managers running it. inflated cash flows to compensate. For In a related vein, companies often AS COMPANIES GLOBALIZE, they face managers keen to complete transaclimit – in arbitrary and puzzling ways – new financial challenges. The first tions, as some at AES were, excessive their considerable expertise in managset of questions summarizes the penalties and precision can result in a ing currency exposures. Many firms work of the traditional finance funcless robust process. require finance managers to follow tion with respect to external providIn extreme cases, the gaming that “passive” policies, which they apply in a ers of capital. Because a global firm takes place in a formalized process can rote manner. For example, GM actively is itself a capital market, the finance undermine the company’s strategy. Conmeasures various exposures but then function must consider a second set sider Asahi Glass, one of the first Japarequires 50% of them to be hedged with of questions, which addresses the nese corporations to rigorously implea prescribed ratio of futures and options. internal capital market, in addition to ment Economic Value Added systems Firms adhere to these passive strategies the first. worldwide in order to increase capital because they limit the degree to which efficiency. Asahi set country-specific financial managers can undertake podiscount rates based on typical risk sitions for accounting or speculative Traditional New measures, including sovereign spreads. reasons. So although functioning in the questions questions for the for the The result, however, was that managglobal environment calls for considerlocal finance global finance ers overinvested in Japan (because of able financial expertise, organizational function function very low discount rates) and underinstrategy requires that expertise to be > How should > How should vested in emerging markets (because of constrained so that financial incentives we finance we finance our very high ones). Once again, adopting don’t overwhelm operating ones. ourselves? subsidiaries? a narrowly financial approach led to an > How should > How should we outcome directly at odds with the comGlobal Capital Budgeting we return cash get money out of pany’s strategic objectives. In response, In addition to exploiting the de facto to shareholders? our subsidiaries? Asahi made a series of adjustments to internal financial market to mediate be> How should > How should we reconcile its initial, purely financial aptween their operations and the external we analyze analyze the same proach to discount rates with its broader financial markets, CFOs can add a lot of investment investment oporganizational goals. value by getting smarter about valuing opportunities? portunities in difThe moral of these stories is that forinvestment opportunities. When energy ferent countries? > How should we mal methods of valuation and capital giant AES began to develop global oper> How should we communicate budgeting – which work quite well in a ations, in the early 1990s, managers apinformation to communicate shareholders financial informadomestic context, where the variables plied the same hurdle rate to dividends and lenders? tion inside the are well understood – must be refined from around the world that they used firm? > How should our as companies globalize. Firms need to for domestic power projects, despite ownership struc- > How should we make sure that their finance professionthe different business and country risks ture influence decide what to als actively discuss potential risks with they faced. That approach made risky operations? own and with the country managers who best underinternational investments look a lot whom? stand them. more attractive than they really were.

The Globally

Finance Function

Competent

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Harvard Business Review 111

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Creating a Global Finance Function plied universally. Such a requirement, however, can sacrifice opportunities that arise locally. Similarly, strategic objectives, How can CFOs ensure that their global finance operations as in the Asahi example, may demand flexibility in investmake the most of the opportunities at their disposal? At a ment analyses. Smart companies, therefore, formulate policies minimum, they must inventory their financial capabilities and centrally with an understanding that local idiosyncrasies and ensure their adaptation to institutional variation and their strategic imperatives may require exceptions. Specifying the alignment with organizational goals. To achieve this, a global process for making exceptions, such as instituting a standing finance function must do three things well: committee of finance professionals to review possibilities, is Establish the appropriate geographic locus of decision critical to ensuring that deviations from the norm are properly making. The example of GM’s approach to hedging makes managed. clear that a finance function must locate decision making at ••• a geographic level where other strategic decisions are made. Even if centralizing decisions can generate substantial savings, Forty years ago, most firms didn’t have CFOs, and the finance these might need to be sacrificed to ensure that the finance function was usually staffed by controllers. As external marfunction reflects the degree of centralization appropriate for kets have become more demanding in terms of performance the firm overall. Highly centralized firms can have a large and their requirements for disclosure, the finance function has finance function at headquarters that effectively dictates debecome more prominent. Now that multinational companies cision making for all subsidiaries; such an arrangement can have their own internal capital markets, the finance function capitalize on many financial arbitrage opportunities without must graduate to a more strategically engaged level. A globally sacrificing organizational goals substantially. Decentralized orcompetent finance department is one that understands how ganizations, in which country managers are paramount, must to reconcile the firm’s financial, managerial, and institutional replicate some financial decision making at the country level. priorities across its business units. Does yours? Create a professional finance staff that rotates globally. Leading companies recruit and rotate financial managers in Mihir A. Desai (mdesai@hbs.edu) is a professor at Harvard the same way that they do marketing and operational talent. Business School in Boston. If companies groom a network of finance professionals who Reprint R0807K To order, see page 163. are comfortable in various environments – and have rotated through positions at the country, region, and corporate levels – the dynamic between the financial headquarters, where most expertise resides, and the subsidiary can be a powerful resource in difficult times. Drug giant Novartis is an example. In 2001, the company had to decide whether to continue financing its Turkish subsidiary, which had repeatedly delayed payment to Novartis during periods of crisis. On the numbers alone, the decision would have been straightforward: Force the managers to fund locally or deny shipments of life-saving drugs to the subsidiary. Complicated negotiations ensured that the subsidiary would continue to operate, capitalize on the weakness of its competitors, and ultimately pay back the parent. A successful outcome was achieved only because of the trust built up over many years between finance managers at headquarters and those in Turkey, many of whom had spent time at Novartis subsidiaries around the world. Codify priorities and practices that can be adapted to local conditions. It is tempting to stipulate that cash repatria“We tried an incentive…it gave him vertigo.” tion policies or investment criteria be ap112 Harvard Business Review
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Scott Harbaugh