Stocks Valuation

stocks valuation
Stocks valuation

Stocks Valuation

1) Rights and advantages belonging to shareholders

Shareholders of a company enjoy following rights and advantages

  • Ownership right: Shareholders being owners of the company enjoy the right to share residual profits left after paying preference dividend. Their rate of dividend is not fixed. It depends upon the amount of profits. Sometimes they get high dividend in case of high profits.
    • Control over management: Shareholders can exercise their control over management through the election of their representatives in the board of directors.
      • The voting right: Shareholders have the right to attend annual general meetings of the company and cast their vote in person or through proxy on various resolutions passed in such meetings. This enables them to participate in corporate and managerial affairs without having to regularly manage affairs directly.
      • Pre-emptive right: At the time of further issue of shares, an offer is made to shareholders first. If shares are left, they are offered to outsiders. It enables them to maintain their proportionate shareholding intact in the company ( H.Sherman, 2011).
      • Transfer of the ownership: Shareholders enjoy the right to transfer the ownership of their securities to others by trading their stock on the stock exchange.

2)      (a)Differences between the S&P 500 Index and the Dow Jones Industrial Average

Both Dow Jones Industrial Average (DJIA) and the S&P 500 are the best known index of American stocks but differentiate from each other in the following manner.

CriterionDow Jones Industrial AverageS&P 500
Introduction It is an oldest stock market index which was introduced in 1896 by Charles Dow (Johnson, 2015).S&P 500 was introduced by S&P Global in 1923 and in its current form, it was published in 1957 ( S&P Dow Jones Indices LLC, 2016).
Index ConstituentsDJIA is composed of thirty publicly traded American companies listed in NYSE and NASDAQ. These stocks are picked by an editor of The Wall Street Journal. It covers a large range of industries in the US except transport and utilities ( S&P Dow Jones Indices LLC, 2016).It is based on market capitalization of 500 large companies listed in NYSE and NASDAQ. It covers a wide range of industries.
Weighting MethodIt is a price-weighted index which is calculated by taking the aggregate of prices of stocks in an index and divided by a common divisor (Johnson, 2015). The stocks having high prices have more weightage in this index.It is a free float capitalization weighted index where in components are weighted on the basis of their market capitalization ( S&P Dow Jones Indices LLC, 2016). The stocks with higher market capitalization have more weightage in this index.

(b)Better measure of stock market performance

The S&P 500 is considered to be the better measure of stock market performance than DJIA because it covers approximately 80% of the stock market capitalization and is considered as a true representative of happenings in the US stock market ( S&P Dow Jones Indices LLC, 2016). DJIA covers 30 securities only and its popularity is because of being an oldest index.

3) Differences between common stock and preferred stock

The main two types of stock issued by companies are common stock and preferred stock which have some similarities as well as dissimilarities. The main dissimilarities between both are given as below:

CriterionPreferred StockCommon Stock
MeaningPreferred stock is a hybrid security which combines features of common stocks as well as debt securities (H.Sherman, 2011). The preference dividend is paid at a fixed rate just like payment of interest at fixed rate, but it is paid out of post-tax profits. It is not termed as ownership security.Common stock is termed as ownership security. Its rate of dividend is not fixed. It depends upon the amount of profits. The amount of dividend may be high in case of high profits and it may be low or even nil in case of low or no profits.
PreferencesPreferred stock carries two preferences over common stock which are (i) Preferred stockholders are paid dividend first before the dividend is declared for common stockholders. (ii) At the time of liquidation of company, preferred stock is redeemed first before any amount is paid to common stockholders (Weaver & Weston, 2001).Common stock holders are paid their periodic dividend as well as redemption value after satisfying claims of preferred stockholders
RightsPreferred stocks do not carry any voting right. But holders get entitled to vote when (i) The dividend has remained unpaid for a specified number of years (H.Sherman, 2011). (ii) The resolution to be passed at the meeting has any impact on their interest.Common stock provides many rights to stock holders which includes voting rights on corporate and managerial issues and preemptive right. Pre-emptive right is the right given to stockholders to maintain their proportionate ownership in the company at the time of further issue of share (Broadridge Advisor Solutions, 2017).

References

Broadridge Advisor Solutions. (2017). Financial Services of America. Retrieved from http://www.fsa1.com: http://www.fsa1.com/Common-Stock-vs–Preferred-Stock.c1019.htm

H.Sherman, E. (2011). The Equity in the Business. In E. H.Sherman, Finance and accounting for nonfinancial managers (pp. 204-205). New York: NY: American Management Association.

Johnson, M. (2015). What’s the difference between DJAI and S&P 500. Retrieved from http://www.nasdaq.com: http://www.nasdaq.com/article/whats-the-difference-between-the-dow-jones-and-the-sp-5001-cm548598

S&P Dow Jones Indices LLC. (2016). S&P Dow Jones Indices. Retrieved from us.spindices.com: http://us.spindices.com/indices/equity/sp-500

Weaver, S., & Weston, J. F. (2001). Financial Statements and Cash flows. In S. Weaver, & J. F. Weston, Finance and Accounting for Non-financial Managers (pp. 26-28). New York: NY: Mc Graw Hill.

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Valuation of Bonds

Valuation of Bonds
Valuation of Bonds

Valuation of bonds

Ques1. Explain what a call provision enables bond issuers to do? Why would bond issuers exercise a call provision?

Answer: A call provision is a clause, mentioned in the bond certificate, which enables the bond issuer to repay or redeem bonds before its maturity date at a specified value (Sherman, 2011). Conditions related to time of redemption or buy back of bonds like amount to be repaid and manner in which payment is to be made are mentioned in advance. This call provision is exercised by the bond issuer at the time when the interest rates have fallen and debts are available at cheaper rate in the market. The issuer redeems the bond carrying high rate of interest and issues new bonds with low rate of interest.

Ques.2 Define a discount bond and premium bond. Provide example of each.

The bond issued by the company for the first time is a standard bond. It becomes discount bond or premium bond depending upon the price at which it is being traded in the market.

Discount bond: If the bond is being traded in the market at a price which is less than the face value, it will be termed as discount bond (Weaver & Weston, 2001). A bond becomes discount bond when it gives interest at a rate which is less than the market rate of interest. The investor will be ready to invest in bonds with lower interest rate if the purchase price of such bond is fixed in such a manner that it compensates the investor for less payment of interest in future. For example: A 5% bond is being issued at $1000. The market interest rate is 4%. The investor will be ready to invest in such bonds if the issue price is less than $1000.

Premium bond: If the bond is being traded in the market at a price which is higher than the face value, it will be termed as premium bond. A bond becomes premium bond, it its coupon rate of interest is more than the prevailing interest rate in the market. The issuer will be ready to issue such bonds if the price is fixed in such a manner that it compensates the issuer for higher payment of interest in future. For example: A 5% bond is being issued at $1000. The market interest rate is 6%. The issuer will be ready to issue such bonds if the price is more than $1000.

Ques3. What is the relationship between interest rates and bond prices?

Answer: The fundamental principle of investment in bond market is that there is inverse relationship between interest rates prevailing in the market and bond prices (SEC, 2013).

                        In market interest rate                  in bond price

                        In market interest rate                  in bond price                                             

If the market interest rate goes up, the investor will be ready to buy bonds with low coupon rate if they are being offered at discount or low price. The investor want compensation for low interest payments to be received in future so he will be ready to buy such debentures if they are being offered at low prices. Similarly if the market interest rate goes down, the investor will be ready to buy the bonds with high coupon rate even at high prices. Thus prices of bond increase.

Ques 4: Describe the difference between coupon bond and zero coupon bond

Answer: The coupon bond is a bond which has coupon rate at which the interest is paid to the bondholder throughout the life of bonds (Sherman, 2011). The bonds are issued with interest coupons and interest is paid to the person who has the possession of coupon. The payment of interest is made at coupon rate and it may be paid quarterly, semi-annually or annually.

Zero coupon bond is a bond which does not carry any coupon of interest as no interest is payable on such bonds. These bonds are issued at deep discount and redeemed at face value on the maturity period. The difference between the issue price and the redemption value is the appreciation value and return for the investor (Weaver & Weston, 2001).

The return for the coupon bondholders is regular in nature whereas the return in case of zero coupon bonds is in the nature of capital appreciation.

References

SEC. (2013). Interest rate risk —When Interest rates Go up, Prices of Fixed-rate Bonds Fall. Retrieved February 2017, from https://www.sec.gov: https://www.sec.gov/investor/alerts/ib_interestraterisk.pdf

Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New York: NY: American Management Association.

Weaver, S., & Weston, J. F. (2001). Finance and accounting for non financial managers (3rd ed.). New York: NY: Mc Graw Hill.

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Worth of money Essay Paper

Worth of money
Worth of money

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Worth of money

Why is money worth more today than at a point in the future? If someone wants the use of your money, should you lend it or invest it in the company? What kinds of risk apply if you lend it? If you invest it? What moral issues are involved? 

Introduction 

In determining whether money is worth more today or in future the ‘time value of money’ concept must be considered which states  that money received today is worth a lot more that the same amount of money in the near future due to the ability of saving this amount and earning interest . Alignment of financial goals and the investment or lending policy is required in order to ensure the chosen option is beneficial in the long term (Advani, 2006). In determining whether to lend or invest money the risks and benefits of both options must be evaluated and the best option implemented.

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When lending money the lender expects to receive their principle amount and any interest that has arisen from the loan .The major risks possessed in lending may be a default of both the interest payments and refusal to pay even the principal amount .The terms of the lending arrangement ma not also be beneficial due to the interest charges agreed (Advani, 2006). 

Worth of money

Before making an investment it is important to evaluate the type of investment that best suits the funds available and the risks involved. The investment idea must match with the individual’s financial objectives. The risk associated with investing is a rapid drop in share prices if one has invested in the stock market a decrease in interest rates if one has invested in bonds and other forms of investment. 

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Conclusion 

Worth of money

Financial goals of the individual should be the key consideration before they decide whether to lend or invest .A risk analysis is also important as it helps in making a sensible decision on the option that is more suitable. The best option should help the individual increase their asset value.

Reference

 Advani, A. (2006). Investors in your backyard: how to raise business capital from people you know Business Loans from Family & Friends: How to Ask, Make It Legal & Make It Work. Nolo.Indiana 

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Investment Decisions in Economics and Finance

Investment Decisions in Economics and Finance
Investment Decisions in Economics and Finance

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Investment Decisions in Economics and Finance

Background

Investment decisions in economics and finance are the decisions made by the investors through investment analysis which is supported by decision tools. Investors use technical and fundamental analysis of the market to achieve satisfactory return against the risk taken. There have been several theories, models and ideas by the scholars and researchers to analyze the market condition and maximize the portfolio expected return while minimizing the risk level.

One of the most common and used theory is the Modern Portfolio Theory or MPT which help to determine lower risks for an investment. In this theory, there are several mathematical models to analysis different factors in an investment like risk and expected return, diversification, efficient frontier with no risk free asset, two mutual fund theorem, capital allocation line and risk free asset. MPT can also help for asset pricing through systematic risk (market risk or portfolio risk), specific risk measurement and capital asset pricing model etc.

In this paper, we are going to calculate expected return, risk premium, standard deviation, covariance, portfolio return and sharp ration for different fractions through case analysis.

Investment Decisions in Economics and Finance

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Case: Pioneer Gypsum

To understand the theories and approaches for investment decisions, we are going to consider the facts of Pioneer Gypsum.

 Expected returnStandard deviationBetaStock price
Pioneer Gypsum10.0%30%0.3$87.50

Table 1: Pioneer Gypsum market status

From these facts, we are going to calculate expected outcome in the market for the company.

Modern Portfolio Theory (MPT)

In investment analysis, MPT is a concept of diversification by using mathematical formula with an aim of finding a set of investment assets that has lower risk all together than any individual asset. The concept behind MPT is that the assets in an investment portfolio should not be selected individually. Instead, it is more significant to consider how each asset changes in price regarding to how every other asset in the portfolio changes in price. Normally, assets with greater expected returns are riskier. For a given amount of risk, MPT shows how to select a portfolio with the maximum promising expected return. Contrary, for a given expected return, MPT describes how to select a portfolio with the lowest possible risk (Elton and Gruber, 1997). 

In spite of its theoretical significance, there have been some criticisms on MPT about whether it is a perfect investing strategy, the reason for that is this concept of financial market does not reflect the real world in several ways. Efforts to interpret the theoretical basis into a feasible portfolio structure algorithm have been diseased by technical difficulties from the volatility of the key problems with respect to the data in hand. Recent findings have proven that instabilities disappear when a restriction or penalty is included in the optimization process (Brodie, De Mol, Daubechies, Giannone and Loris, 2009).

Many researchers criticize the Modern Portfolio Theory as: it does not reflect the market in practical sense and it does not take its own effect in account for asset prices.

The Modern Portfolio Theory gives several mathematical models regarding market analysis and calculates risk and return.

Investment Decisions in Economics and Finance

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Expected Return

According to the Modern Portfolio Theory, the mathematical equation of expected return is:

Where  Return on the profit

 = Return on assed i

wi = Weighting of component asset i

Portfolio return variance:

Here, ρij = the correlation coefficient between the returns on assets i and j

For two asset portfolio, 

The portfolio return: 

 \operatorname{E}(R_p) =  w_A \operatorname{E}(R_A) +
w_B \operatorname{E}(R_B) = w_A \operatorname{E}(R_A) + (1 - w_A) \operatorname{E}(R_B).

The portfolio variance:

For Pioneer Gypsum, the expected return would be:

CAPM

CAPM or the Capital Asset Pricing Model was introduced by Jack Treynor in 1961 (French, 2003). The model is used to establish a theoretically approach to determine the required rate of return for an asset, if the asset is to be joined in an well diversified portfolio with the fact that the asset is at non diversifiable risk. The theory takes into account the sensitivity of the asset to non diversifiable risk (i.e. market risk or systematic risk) as well as the expected return of theoretical risk free asset and the expected return of the market. It is often symbolized by the quantity beta (β) in the investment analysis.

Searchers have fount quite a few problems in the theory of CAPM. The most notables among them are:

  • According to this model, asset returns are normally distributed as random variables and potential shareholders uses a quadratic outline of the utility. However, it is often found that returns in equity and other markets are not circulated in general way. Because of that, large swings (3 to 6 standard deviations from the mean) takes place in the market more than the normal distribution theory would anticipate (Mandelbrot and Hudson, 2004)
  • This model also employs that the guesses of potential and active shareholders on possibilities go with the true distribution of returns. Another possibility tells that the expectations of potential and active shareholders are prejudiced, which causes market prices to be unproductive. This factors is studied in behavioral finance, which takes account of psychological assumptions to bring new alternatives for CAPM  like the overconfidence based asset pricing theory (Daniel,  Hirshleifer, and Subrahmanyam, 2001)
  • In theory, a market portfolio should have all types of assets that are held as an investment (i.e. real estate, art works and human capital etc.). In real, such market portfolio is not possible and individuals usually replace the true market portfolio in the place of a stock index. It has been proven that this replacement is not inoffensive and most likely can guide to miss-inferences as to the legality of CAPM. Also, this theory might not be empirically experiment able because of the lack of its potential outcomes in the real market portfolio (Roll, 1977)

Investment Decisions in Economics and Finance

The mathematical formula of CAPM depends on two facts, the security market line and its relation with systematic risk and expected return. From this relationship, we obtain the Capital Asset Pricing Model with the following equation:

Here:

 = the expected return on the capital asset

 = the risk free rate of interest

 = the sensitivity of the expected excess asset returns

 = the expected return of the market

 =   the difference between the expected market rate of return and the risk free rate of return

Beta

The term Beta (β) refers to a number is that describes the relation of its returns for a portfolio with those of the financial market all together (Levinson, 2006). If the return of an asset changes autonomously according to the changes in the return of the market, it has a Beta of zero. A positive beta means that the return of the asset follows the return of the market. On contrary, a negative beta means that the return of the asset follows the opposite movement of the returns of the market. The beta coefficient is a key parameter in the CAPM.

Seth Klarman criticized Beta by saying that it fails to consider specific economic developments and business fundaments (Klarman & Williams, 1991).

Investment Decisions in Economics and Finance

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 The mathematical expression of Beta is

Where  = beta coefficient

 = the rate of return of the asset

 = rate of return of the portfolio

 = covariance between the rate of the return

Investment Decisions in Economics and Finance

Risk Premium

The term Risk Premium refers to the minimum amount of money which must exceed the confirmed return from a risk free asset comparing to the expected return on a risky asset. This is accounted when an individual is holding a risky asset instead of a risk free asset. The premium is the minimum compensation for the risk that the individual is willing to accept.

Investment Decisions in Economics and Finance

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The mathematical expression for calculating the risk premium is

Where u = concave von Neumann-Morgenstern utility function

 = return on the risk free asset

r = random return on the risky asset

x = zero-mean risky component

= hypothetical expected return

Standard Deviation

The standard deviation is used to determine the variation from the average or expected value. A low standard deviation means that the date points are close to the average and a high standard deviation means spread out data points over large array.

Investment Decisions in Economics and Finance

Sharpe Ratio

Sharp ratio is used to measure the risk premium per unit of deviation in an investment asset. Mathematically, it is expressed by the equation:

Here, R = asset return

= return on a benchmark asset

 = expected value of the excess of the asset return over the benchmark return

 = standard deviation

Covariance Matrix

The covariance matrix is the type of matrix where the elements in the i, j position are the covariance between the ith and jth elements of a random vector. Each element of the covariance vector is a random scalar variable, each with a finite number of experiential empirical values or with an infinite or finite number of possible values précised by a theoretical combined probability distribution of all the random variables.

Investment Decisions in Economics and Finance

Conclusion

Investment decisions as decisions made by the investors assist investors to achieve satisfactory return against the risk taken. One of the most common and used theory is the Modern Portfolio Theory or MPT which help to determine lower risks for an investment MPT can also help for asset pricing through systematic risk (market risk or portfolio risk), specific risk measurement and capital asset pricing model. Through calculating the expected return, risk premium, standard deviation, covariance, portfolio return and sharp ration for different fractions it becomes possible for an investor manage the investment in a professional manner.

References

Edwin J. Elton and Martin J. Gruber (1997) Modern portfolio theory, 1950 to date. Journal of Banking & Finance 21

Brodie, De Mol, Daubechies, Giannone and Loris (2009). Sparse and stable Markowitz portfolios Proceedings of the National Academy of Science 106 (30)

French, Craig W. (2003). The Treynor Capital Asset Pricing Model, Journal of Investment Management, Vol. 1, No. 2, pp. 60–72

Mandelbrot, B.; Hudson, R. L. (2004). The (Mis)Behaviour of Markets: A Fractal View of Risk, Ruin, and Reward. London: Profile Books

Daniel, Kent D.; Hirshleifer, David; Subrahmanyam, Avanidhar (2001). “Overconfidence, Arbitrage, and Equilibrium Asset Pricing”. Journal of Finance 56 (3): 921–965

Roll, R. (1977). “A Critique of the Asset Pricing Theory’s Tests”. Journal of Financial Economics 4: 129–176

Levinson, Mark (2006). Guide to Financial Markets. London: The Economist (Profile Books). pp. 145–6

Klarman, Seth; Williams, Joseph (1991). “Beta”. Journal of Financial Economics 5 (3): 117

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Foreign Direct Liability Research Paper

Foreign direct liability
Foreign direct liability

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Foreign direct liability 

Critically analyse what you understand by foreign direct liability 

And

Critically evaluate the legal obstacles in regulating the activities of multinational companies.

An analysis of Multinational corporation operations and foreign direct liability.

Foreign direct liability 

Introduction

Over time, parent companies mostly in developed countries have set their sights on foreign markets. This has led to an increased number of multinational companies. Multinational companies (MNCs) are defined as enterprises that have production and delivery services in more than one country.[1]  Thus, the location of the company’s headquarters is referred to as the home country while the host countries are the other countries that it has invested in.

This has been facilitated by increased competition and globalization. Driven by the motivation to maximize profits, these companies have extended their boundaries all over the world. Most of them have even penetrated what would be termed as high risk areas. These are mostly war torn countries or those that have poor governance relating to dictatorial leadership.

In their quest to set base in foreign markets, these companies have to interact with the locals.  Foreign direct Investment has experienced exponential growth in developing countries. World trade has exceeded $15 trillion over the last three decades. In the 1990s, a large portion of external finance in developing countries was attributed to foreign direct investment.[2]Their presence in these markets has led to great benefits.

Not only do the people benefit from employment, but impartation of new skills. Moreover, the multinational companies introduce new technology and knowledge[3]. In addition to this, the entry of multinational companies into these markets has put the developing nations on the trade map. Their entry has also contributed to the utilization of a country’s resources.[4]

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In order for these companies to establish themselves, they consider certain factors. These are known as the push and pull factors. The push factors force the companies from their home countries whereas pull factors lure them to new locations. Market based factors consider labor costs, information skills, investment incentives and management prowess. Efficiency based factors include common governance, economy of scope, production incentives and product specialization.

Strategic based factors on the other hand consider market access, distribution of the product, customer access and performance and input quality protection. Lastly, resource based factors are another key consideration. These include availability of capital and natural resources, supply stability and market controls.

In choosing to establish themselves in host countries, the MNCs are forced to adapt to the standards set by the jurisdiction they’ve chosen to operate in. Hence they align their production processes to the demands of the host country. With regards to labor costs, MNCs trend over the years is to pay the workers in the developing countries low wages.

It should be noted that once MNCs establish enter foreign markets, they become vulnerable to arbitrary government actions such as sudden contract renegotiations, being forced to but licenses or arbitrary withdrawal of the same or in some instances, expropriation.

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Nevertheless, MNCs play a major role in any market they enter. They impact government policy significantly. They influence how the government formulates policies regarding the country’s economy. Where the policy does not favor the multinational corporations, they threaten to withdraw from the market.[5] This is especially common with MNCs that have monopoly in a particular sector. Countries like the United States however, have managed to curb this through the presence of domestic market competitors.

Another avenue provided for MNCs to influence government decision is through lobbying. In the United States, an individual or group’s ability to lobby is enshrined in the right of petition contained in the Amendment to the United States Constitution.[6] Lobbying in the United Kingdom is considered as a way of promoting democracy. A statutory register for lobbying and lobbyists was recommended by the House of Commons Public Administration Select Committee.[7] 

In the European Union, lobbying is done with the aim of influencing the European Parliament, the Council and the Commission.[8] Multinational corporations lobbying is directed at a range of issues such as the tariff structures and environmental regulations. Their purpose for lobbying on some of these issues is to filter out competitors. For instance, if a multinational company pushes for stringent standards on environmental safety, any other competitor that is unable to meet the requirements is automatically locked out.

Wal-Mart, a multinational corporation in the USA benefited from the zoning laws that created barrier to entry for other companies.[9] The zoning laws spelled out the areas that could be developed and for what purpose, regulating building heights, lot coverage and other aspects pertaining to land use.[10]

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In maintaining monopoly in a given sector, these corporations acquire patents. For instance, Adidas, renowned shoe manufactures, holds a patent to protect its shoe designs whereas Microsoft holds a software patent.[11]

International law and treaties.

Besides the individual national laws that govern sovereign states, the public international law was instituted to govern the relationship among sovereign states.[12] Hence, multinational corporations are affected by the international law. Increased global trade, environmental degradation and human rights violations have increased the importance of international law which is used to govern these issues.

In addition to this, international law is used to solve disputes that arise from the interpretation of and implantation of national laws.[13] The sources of international law are customs and treaties.  Treaties result from consent to follow them by a number of countries while customary international law emerge from practices carried out by nations that believe they ought to be part of international law.[14] 

Customary law has been used by environmentalists to affirm the need for countries and corporations to take care of the environment. This is clearly outlined in Principle 21 of the Stockholm Declaration and Principle 2 of the Rio Declaration.[15] These principles give the countries the right to exploit their resources but not to the extent of damaging the environment of areas beyond their jurisdiction.

Several treaties have also been established in relation to environmental protection. For instance, 2001 Stockholm Convention on Persistent Organic Pollutants prohibits the use of certain chemicals while putting restrictions on the use of others.[16] Nuclear and air pollution is also regulated by the International Convention on Oil Pollution Preparedness. Voluntary Corporate Codes of Conduct have also been established. The ISO 14000 established by the International Organization for Standardization is a set of environmental management standards that corporations voluntarily adopt to prevent pollution.[17]

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Foreign Direct Liability.

The negative impacts of multinational companies have led to the emergence of the foreign direct liability concept. The negative impacts have driven the locals to seek legal action against the multinational companies in their home countries.[18] The claims often relate to negative environmental and health impacts on the locals caused by a company’s operations in the area. For instance, in the US, cases have been brought forth against Union Carbide, Texaco, Unocal and Freeport McMoRan.

Union Carbide, a US based corporation invested in India. On December 3, 1984, the plant experienced a gas leak that killed 3,787 people and another 8000 that died from gas related diseases. [19] Immediately after the catastrophe, the company, Indian and U.S governments embarked on legal proceedings. The CEO of Union Carbide, Warren Anderson was summoned to the US Congress.

Not satisfied, in March 1985, the Indian government formulated the Bhopal Gas Leak Act that mandated it to be the legal representative of the victims.[20] The case was later transferred to India for hearing. This was challenged by Union Carbide management but was not supported by the US courts. In June 2010, 7 of the former UCC employees were convicted for negligence that caused the deaths. 

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This is just one of the cases where foreign citizens have sought litigation in the home countries. As seen in the Bhopal case, due to failure to determine under which law the case was to be heard, there was a lot of back and forth between the Indian and the US government. Consequently, those responsible for the 1984 disaster were convicted sixteen years later. This clearly outlines the need to harmonize the legal systems between the home and host countries. Whenever a multinational company invests in another country, there should be clear guidelines on how cases involving the locals will be handled.

Foreign direct liability may have an impact on corporate performance.[21] Since the litigation process is an expensive course and in the event that the corporation losses against the plaintiffs and are forced to compensate them, then this is a factor that would cause the corporations to rethink their actions in the host country. Therefore, foreign direct liability may push them towards implementing risk management strategies.

In addition to this, the home countries can however play a role in regulating the influence of multinational corporations in the host countries in terms of the foreign direct investment.[22] The home country governments can limit the amount of investments an MNC can have. This will help to reduce their monopoly in foreign markets.

However, the MNCs have devised other means of avoiding foreign direct liability.[23] Among the measures they use is contracting what they view as the risky parts of their activities to subcontractors. Secondly, they insulate the parent company from any claims by separating the day to day management of the parent company from those of its subsidiaries.

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Another factor to be considered is the involvement of the local government in the corporations’ activities. They take part as business partners or beneficiaries. Hence, the host governments are likely to turn a blind eye on the MNCs activities.[24] This makes the victims’ quest for justice a big challenge. Worse yet is that even if the victims win and are to be compensated, the local subsidiaries may not be in a position financially to fulfill their obligations. 

When analyzed from a corporate social responsibility (CSR) point of view, it ought to be the responsibility of these corporations to ensure that their workers have favorable working conditions.[25] By this, they should apply the same standards they apply at home in the host country. The issue of different standards at home and abroad should not arise. Hence, the best environmental and health standards should be applied wherever they choose to invest.

On the other hand, foreign direct liability opens up the host country to impositions by the home country.[26] The home country courts are likely to demand to have their way with regards to the host government’s choices. They may demand very high standards that the host government may not be in a position to meet based on the developing countries’ status. In the event that a disaster occurs, then the company together with the home government absolve themselves from any responsibility laying the blame on the host government for failure to implement their recommendations.

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Political, legal and social risks.

Besides this, multinational corporations face a lot of risks in their foreign operations. They are forced to deal with additional costs arising from their unfamiliarity with the foreign market, discrimination from the customers, suppliers or government entities[27]. Moreover, other costs are associated with international operations.

Multinationals also stand the risk posed by political decisions arrived at by a country’s governance.[28] Political changes that alter the expected outcome of a given economic action determine the probability of a company’s prosperity in the given country. These risks may be classified as micro-level political risks and macro-level political risks.

Macro-level political risks do not only refer to country level political risks, rather it is a coupling of local, national and regional political events. These risks may result in confiscation or seizure of a businesses’ property. Micro-level political risks on the other hand may be termed as project-specific risks. These risks tend to favor the local industries compared to multinational companies.

Micro risks arise from prejudicial actions or corruption. A good example of how companies can suffer from political risks is illustrated by Cuba. Following Fidel Castro’s takeover of Cuba in 1959, American owned assets and companies were expropriated as explained by Simon.[29] These companies incurred losses to the tune of hundreds of millions of dollars.

Macro level risks can be mitigated by the company understanding the political uncertainties of the host country. At the micro level, political risks can be mitigated through political risk insurance and hedges.  Institutions such as Multilateral Investment Guarantee Agency (MIGA) and Overseas Private investment Corporation (OPIC) are just but a few of the public sector insurers that provide project specific political risk insurance.

Through insuring investors, MIGA promotes foreign direct investment in developing countries[30].  OPIC is an American based agency that mobilizes the private sector to invest in new and emerging markets. Portfolio of investments can be covered by private market insurers. Political risk insurance covers a variety of risks that the investor may face. These are currency inconvertibility, expropriation; loss of an investment due to confiscation by the host government; and political violence.

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In addition to this, legal risks are another challenge for MNCs. This results from a lack of clear guideline on the law applicable when a legal matter arises. For instance, the foreign direct liability cases prove to be a challenge as to which law to apply in determining the cases. The difference in the legal cultures of the host and home countries become barriers to the resolving of such cases.

Social risks on the other hand arise from crimes, violence and racial discrimination.[31] Multinational companies tend to be victims of crimes. This may be attributed to lack of confidence by the locals in their operations.[32] To add to this, people’s perception about a company influences the decisions they make. Multinational companies fall prey to this menace especially from customers who may view a company in a particular way. Wrong perception may also arise from lack of information about a company’s operations.[33]

Wal-Mart Company has faced a series of criticism from labor organizations, human rights activists and other entities.[34] This has given their consumers a negative perception about the company. Apart from this, multinational companies face racial discrimination from locals in the host countries. The domestic markets have a higher tendency of favoring the local industries compared to the foreign companies. 

One of the ways of mitigating social risks is through corporate social responsibility.[35] Creating programs that help the MNCs keep in touch with the locals serves a good strategy to deal with the perceptions the locals may have about it. Some of these programs include creating social events where both parties can interact such as fun days for the employees. In addition, some MNCs have gone ahead to engage in programs that meet the needs of the locals such as establishing schools, providing water and other social amenities. Moreover, transparency about the companies’ operations also contributes to mitigating social risks.

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Conclusion. 

In conclusion, multinational corporations are companies that have extended their operations from the home countries to foreign markets that are referred to as the host countries. These companies take into consideration the viability of the foreign markets before they establish themselves. Their entry into the host country implies involvement of the locals in the company’s operations. In addition to these, international laws have been put in place to govern the management of resources with respect to health and environmental safety.

Multinational countries tend to have different standards in the home and host countries. This gives rise to foreign direct liability. Access to justice is the underlying issue in foreign direct liability. The victims in most instances seek justice in the home country. However, this is still a foreign concept to many countries. As seen, multinational companies face several risks including legal, political and social. All in all, there is a need to develop a strategy where foreign direct liability is handled amicably and justice is served. Moreover, multinational companies need to not only be driven by the desire to make profits but work towards corporate social responsibility.

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BIBLIOGRAPHY

Book sources:

Aitken J.Brian and Harrison E. Anne, “Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela,”, p.1, June 1999.

Barber, Jeffrey, “Responsible Action or Public Relations? NGO Perspectives on Voluntary Initiatives,” Industry and Environment, 1998.

Barnett, Richard, Global Reach: The Power of the Multinational Corporations, 1975.

Broughton, Edward  “The Bhopal disaster and its aftermath: a review”Environmental Health, 2005.

“Chronology”. Bhopal Information Center, UCC. November 2006.

Donovan, P. J. “Creeping Exportation and MIGA” 2004

Enneking , F.H. Liesbeth,  “Crossing the Atlantic? The political and legal feasibility of European Foreign Direct Liability Cases,” The George Washington International Law Review, p 903, 2009.

 Handl Gunther and Lutz, E. Robert Transferring Hazardous Technologies and substances: The International Legal Challenge, 1989.

 Helleiner, K. Gerald, “Transnational Corporations and Direct Foreign Investment Handbook of development economics. Amsterdam: North-Holland, 1989.

Henkin, Louis, How Nations Behave. 1968, pp. 47.

 Holzmann, Robert; Steen Jorgensen (2000). “Social Risk Management: A new conceptual framework for Social Protection, and beyond”World Bank. 2006.

How managing political risk improves global business performance,” PwC Advisory and Eurasia Group, 2006.

Hymer, S, The International Operations of National Firms: A Study of Direct Investment,

MIT Press, Cambridge, MA. 1976.

Jenkins, Beth; Kutle Beth and Bekefi, Tamara, ‘Social Risk as Strategic Risk’, Corporate Social Responsibilty Initiative, December 2006

Lefcoe, George, “The Regulation of Superstores: The Legality of Zoning Ordinances Emerging from the Skirmishes between Wal-Mart and the United Food and Commercial Workers Union,” April 2005.

Luo, O. Shenkar, and Nyaw,M.,  “Mitigating liabilities of foreignness: defensive versus offensive approaches”, Journal of International Management, Vol. 8 No. 3, pp. 283-300. 2002.

Luo, Y., “Market-seeking MNEs in an emerging market: how parent-subsidiary links shape overseas success”, Journal of International Business Studies, Vol. 34 No. 3, pp. 290-309, 2003.

Mezias, J.M., “Identifying liability of foreignness and strategies to minimize their effects: the case of labor lawsuit judgments in the United States”, Strategic Management Journal, Vol. 23, pp. 229-44, 2002.

Magraw, Barstow Daniel International Law and Pollution, 1991.

Pitelis Christos & Sugden Roger, The nature of the transnational firm 2000.

Holzmann, Robert; Lynne Sherburne-Benz and Emil Tesliuc. “Social Risk Management: The World Bank Approach to Social Protection in a Globalizing World”.World Bank., 2006.

Santoro, M., Should LDCs love MNCs? Foreign Policy, 128, 94-96, 2002.

Sethi,D  and S. Guisinger,S., “Liability of foreignness to competitive advantage: how multinational enterprises cope with the international business environment”, Journal of International Management, 2002

Shaw, M. N.  International Law 5th edn, Cambridge University Press, 2003

Weiss, Brown Edith; Barstow Daniel and Szasz, C.Paul, International Environmental Law: Basic Instruments and References, 1992.

Journal and other publications:

Kierkegaard, Sylvia, How the Cookie (almost crumbled). Computer Law and Security Report Vol.21 Issue 4, 2005.

Kyle, Beth and Ruggie, G. John, “Corporate Social Responsibility as Risk Management” Corporate Social Responsibility Initiatice Working Paper, Cambridge MA: John F. Kennedy School of Government, Harvard University, 2005.

Simon, D.J., “A Theoretical Perspective on Political Risk”,), Journal of International Business Studies, Vol. 15, No. 3,Winter, 1984.

“The Right to Petition”. Illinois First Amendment Center.

Town and Country Planning Act 1990

Ward, Halina,”Foreign Direct Liability’: A New Weapon in the Performance Armoury?” AccountAbility Quarterly, Issue14, 2000.

Web sources:

Kevin Carson, Tucker‘s Big Four: Patents., Mutualist.Org,

http://www.mutualist.org/id74.html> (accessed on 30 Nov 2011) 

The Economic Impact of Wal-Mart,” Global Insight, http://www.globalinsight.com/gcpath/Wal-Mart 2006, (accessed on 30 Nov 2011)

Public Administration Select Committee,

 < http://www.parliament.uk/business/committees/committees-a-z/commons-select/public-administration-select-committee/>2005, (accessed on 30Nov 2011)

Seun Oluwanisola, Ezine articles, < http://ezinearticles.com/?Benefits-and-Challenges-of-Multinational-Companies->,2011, ( accessed on 30 Nov 2011)


[1] Christos Pitelis & Roger Sugden, The nature of the transnational firm 2000.

[2]  Brian J. Aitken and Ann E. Harrison, “Do Domestic Firms Benefit from Direct Foreign Investment?

Evidence from Venezuela,” June 1999, p.1

[3]  Gerald K. Helleiner,“Transnational Corporations and Direct Foreign Investment Handbook of development economics. Amsterdam: North-Holland, 1989.

[4] Seun Oluwanisola, Ezine articles, < http://ezinearticles.com/?Benefits-and-Challenges-of-Multinational-Companies-> ,2011, ( accessed on 30 Nov 2011)

[5] Barnett, Richard, Global Reach: The Power of the Multinational Corporations, 1975

[6] “The Right to Petition”. Illinois First Amendment Center.

[7] Public Administration Select Committee < http://www.parliament.uk/business/committees/committees-a-z/commons-select/public-administration-select-committee/> (accessed on 30Nov 2011)

[8] Kierkegaard, Sylvia, How the Cookie (almost crumbled). Computer Law and Security Report Vol.21 Issue 4, 2005.

[9] Lefcoe, George, “The Regulation of Superstores: The Legality of Zoning Ordinances Emerging from the Skirmishes between Wal-Mart and the United Food and Commercial Workers Union,” April 2005.

[10] Town and Country Planning Act 1990

[11] Kevin Carson, Tucker‘s Big Four: Patents., Mutualist.Org < http://www.mutualist.org/id74.html> (accessed on 30 Nov 2011) 

[12] M. N. Shaw, International Law 5th edn, Cambridge University Press, 2003

[13] Henkin, Louis, How Nations Behave. 1968, pp. 47.

[14]Daniel Barstow Magraw, International Law and Pollution, 1991.

[15] Edith Brown Weiss, Daniel Barstow and Paul C. Szasz, International Environmental Law: Basic Instruments and References, 1992.

[16] Gunther Handl and Robert E. Lutz, Transferring Hazardous Technologies and substances: The International Legal Challenge, 1989.

[17] Jeffrey Barber, “Responsible Action or Public Relations? NGO Perspectives on Voluntary Initiatives,” Industry and Environment, 1998.

[18]Halina Ward,”Foreign Direct Liability’: A New Weapon in the Performance Armoury?” AccountAbility Quarterly, Issue 14, 2000.

[19] Broughton, Edward, “The Bhopal disaster and its aftermath: a review”Environmental Health, 2005.

[20] “Chronology”. Bhopal Information Center, UCC. November 2006.

[21] D. Sethi,  and S. Guisinger, “Liability of foreignness to competitive advantage: how

multinational enterprises cope with the international business environment”, Journal of

International Management,  2002.

[22] Santoro, M., Should LDCs love MNCs? Foreign Policy, 128, 94-96, 2002.

[23] J.M. Mezias, “Identifying liability of foreignness and strategies to minimize their effects:

the case of labor lawsuit judgments in the United States”, Strategic Management Journal,

Vol. 23, pp. 229-44, 2002.

[24] Liesbeth F.H. Enneking , “Crossing the Atlantic? The political and legal feasibility of European Foreign Direct Liability Cases,” The George Washington International Law Review, 2009, p 903.

[25]Y. Luo, O. Shenkar, and  M. Nyaw,  “Mitigating liabilities of foreignness: defensive versus

offensive approaches”, Journal of International Management, Vol. 8 No. 3, pp. 283-300. 2002.

[26] Y. Luo,,“Market-seeking MNEs in an emerging market: how parent-subsidiary links

shape overseas success”, Journal of International Business Studies, Vol. 34 No. 3,

pp. 290-309, 2003.

[27] S. Hymer, , The International Operations of National Firms: A Study of Direct Investment,

MIT Press, Cambridge, MA. 1976.

[28] How managing political risk improves global business performance,” PwC Advisory and Eurasia Group, 2006.

[29] D.J.,Simon, “A Theoretical Perspective on Political Risk”, (Winter, 1984),  Journal of International Business Studies, Vol. 15, No. 3. (pp. 123–143).

[30] P. J. Donovan, “Creeping Exportation and MIGA” 2004.

[31] Holzmann, Robert; Lynne Sherburne-Benz and Emil Tesliuc. “Social Risk Management: The World Bank Approach to Social Protection in a Globalizing World”World Bank., 2006.

[32] Holzmann, Robert; Steen Jorgensen (2000). “Social Risk Management: A new conceptual framework for Social Protection, and beyond”World Bank. 2006.

[33] Beth Jenkins, Beth Kutle and Tamara Bekefi, ‘Social Risk as Strategic Risk’, Corporate Social Responsibilty Initiative, December 2006.

[34] The Economic Impact of Wal-Mart,” Global Insight, http://www.globalinsight.com/gcpath/Wal-Mart 2006, (accessed on 30 Nov 2011)

[35] Beth Kyle and John G. Ruggie, “Corporate Social Responsibility as Risk Management” Corporate Social Responsibility Initiatice Working Paper, Cambridge MA: John F. Kennedy School of Government, Harvard University, 2005.