Joint determination of trade, production and financial flows in the multinational firm assuming risky currency exchange rates : a two-stage linear programming model building approach

Abstract

Problems relating to big multinational business enterprises have been subject to much research effort and debate for about two decades. This results from the considerable role played by such enterprises in the world economy. Recently one emerging research trend in this context has been towards building operations research models for global decision making in the multinational firm. This is natural since research on the application of operations research techniques to the planning problems of national firms has been expanding at a fast pace. In the case of the multinational firm short-term (~ tactical) management of finance has been subject to most research of this kind. The separation of the treatment of physical and financial flows is a simplification, however, which can lead to nonoptimal total plans.

Several authors have presented mathematical programming models for the (tactical) planning of finance in the multinational firm under the assumption that the physical activities (trade and production) have first been fixed at a preceding planning stage. The most advanced of these models are constructed to include the probabilistic nature of currency exchange rates.

Linear programming models have also been presented for the planning of trade and production in the multinational firm. Furthermore, linear programming models have been constructed for joint planning of physical and financial flows in the multinational firm under the assumption of deterministic currency exchange rates. In addition to the determinism of the currency exchange rates it should be noted that these models treat certain decision variables as fixed or omit them. These simplifications can lead to suboptimal total planning, too.

It is my purpose to propound how certain tactical decisions, which earlier O.R. modelling research has treated only separately, can be simultaneously treated in a manageable way in mathematical programming models for the multinational firm: In this dissertation I show how the probabilistic nature of currency exchange rates (= "currency risk") can be taken into account in linear programming models for joint planning of trade, production, and financial flows in the multinational firm. This will mean that only the (discrete) probability estimates of future exchange rates have to be assumed to be available to the decision maker. The inclusion of currency risk is achieved by applying two-stage linear programming.

I also show how forward contracts can be included in linear programming models for joint determination of trade, production, and financial flows in the multinational firm facing risky currency exchange rates.

Furthermore, I demonstrate how the exposure of assets and liabilities to currency risk can be adjusted to fit into predetermined bounds.

I demonstrate the inclusion of interaffiliate transfer prices, which are declared for duty and tax assessment, as well as the inclusion of interaffiliate interest rates as decision variables in the kind of models discussed. I suggest a concept of "shadow transfer prices" for the analysis of interaffiliate transfer price bounds.

The construction of separate equations for the formulation of the objective function and the treatment of taxation is found to be advantageous.

I also briefly discuss the possibility of using the propounded normative model as a behavioral model of the multinational firm.

Particular attention is given to retaining readability, even at the cost of scientific rigor. This dissertation is thus meant to be applicable also as an advanced textbook in operations research and multinational management