Motivation for Raising Funds Outside of the Domestic Market There are four reasons why a corporation may seek to raise funds outside

Motivation for Raising Funds Outside of the Domestic Market There are four reasons why a corporation may seek to raise funds outside

of its domestic market. First, in some countries, large corporations seek- ing to raise a substantial amount of funds may have no other choice but to obtain financing in either the foreign-market sector of another country or the Euromarket. This is because the fund-raising corporation’s domes- tic market is not fully developed to be able to satisfy its demand for funds on globally competitive terms. Governments of developing coun- tries have used these markets in seeking funds for government-owned corporations that they are privatizing.

The second reason is that there may be opportunities for obtaining a reduced cost of funding (taking into consideration issuing costs) com- pared to that available in the domestic market. With the integration of capital markets throughout the world, such opportunities have dimin- ished. Nevertheless, there are imperfections in capital markets through- out the world that prevent complete integration and thereby may permit

a reduced cost of funds. These imperfections, or market frictions, occur because of differences in: security regulations in various countries, tax

4 This classification is by no means universally accepted. Some market observers and compilers of statistical data on market activity refer to the external market as con-

sisting of the foreign market and the Euromarket.

SELECTED TOPICS IN FINANCIAL MANAGEMENT

structures, restrictions imposed on regulated institutional investors, and the credit risk perception of the issuer. In the case of common stock, a corporation is seeking to gain a higher value for its stock and to reduce the market impact cost of floating a large offering.

The third reason to seek funds in foreign markets is a desire by cor- porate treasurers to diversify their source of funding in order to reduce reliance on domestic investors. In the case of common stock, diversify- ing funding sources may encourage investment by foreign investors who have different perspectives of the future performance of the corpora- tion. There are two additional advantages of raising foreign equity funds from the perspective of U.S. corporations: (1) some market observers believe that certain foreign investors are more loyal to corpo- rations and look at long-term performance rather than short-term per- formance as do investors in the United States; and (2) diversifying the investor base reduces the dominance of U.S. institutional holdings and its impact on corporate governance.

Finally, a corporation may issue a security denominated in a foreign currency as part of its overall foreign-currency management. For exam- ple, consider a U.S. corporation that plans to build a factory in a foreign country where the construction costs will be denominated in that for- eign currency. Also assume that the corporation plans to sell the output of the factory in the same foreign country. Therefore, the revenue will

be denominated in the foreign currency. The corporation then faces exchange-rate risk: The construction costs are uncertain in U.S. dollars because during the construction period the U.S. dollar may depreciate relative to the foreign currency. Also, the projected revenue is uncertain in U.S. dollars because the foreign currency may depreciate relative to the U.S. dollar. Suppose that the corporation arranges debt financing for the plant in which it receives the proceeds in the foreign currency and the liabilities are denominated in the foreign currency. This financing arrangement can reduce risk because the proceeds received will be in the foreign currency and will be used to pay the construction costs, and the projected revenue can be applied to service the debt obligation.

Corporate Financing Week asked the corporate treasurers of several multinational corporations why they used nondomestic markets to raise funds. 5 Their responses reflected one or more of the reasons cited above. For example, the director of corporate finance of General Motors said that the company uses the Eurobond market with the objective of “diversifying funding sources, attracting new investors and achieving comparable, if not, cheaper financing.” A managing director of Sears

5 Victoria Keefe, “Companies Issue Overseas for Diverse Reasons,” Corporate Fi- nancing Week (November 25, 1991, Special Supplement), pp.1 and 9.

International Financial Management

Roebuck stated that the company “has a long-standing policy of diversi- fying geographical [funding] sources and instruments to avoid reliance on any specific market, even if the cost is higher.”