Capital Structure There Are a Essay

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The company finances foreign operations with debt from a number of different countries. It does this on the basis of the parent company's credit rating, which illustrates that the implicit understanding with respect to the parent company default guarantee of subsidiary debt holds across different debt markets (Stern & Chew, 2003, 394).

There are also times when the capital structure is determined more by strategic considerations than any other. Many firms operate foreign subsidiaries as joint ventures, for example, because this gives the firm greater access to foreign capital markets and usually reduces the country risk and market risk associated with the subsidiary, when compared to a greenfield subsidiary. There is evidence that firms using this tactic do so in part to reduce the costs associated with foreign market entry, including financing costs. Hennart's (1991, 483) study of Japanese subsidiaries in the United States showed that transaction costs played a critical role in the choice of capital structure for Japanese firms entering the United States. Local partners were found not only when this had strategic benefits but also when it would reduce the cost of capital. When a reduction of costs is not obtainable from a joint venture, a joint venture is typically not pursued.

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Toyota, which moved into the United States in the early 1980s, is an example of this theory in practice. Access to the U.S. market also gave the company access to U.S. capital markets, including the New York Stock Exchange. In this case, Toyota adopted the cost reduction strategy when it finally built its own plant in the U.S.

In practice, most firms appear to tailor their local market capital structure based on the cost reduction model. When moving into foreign markets, firms typically seek to lower their cost of capital by adjusting their capital structure to local conditions. Joint ventures give firms access to local capital markets, for example. Utilizing the home country capital structure places constraints on the subsidiary that could impact on its profitability so that option is not typically pursued. The literature does not support the idea that firms conform to the capital structure norms of the foreign country -- indeed to do so would compel the firm to surrender any competitive advantage on the cost of capital it might have. The literature in general suggests that firms only use a local capital structure when it would accrue cost savings from doing so.

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