International finance fundamentals and applications

¶ … L Finance

Firms operating internationally can find themselves dealing with additional regulatory risks that must be taken into consideration when making investments. Starbucks notes in its 2011 Annual Report (p.12) that there are several regulatory issues that can affect financial decisions including those concerning foreign currency exchange rates, intellectual property rights protections, licensing requirements and contract rights. Other measures could include those concerning duties and tariffs, restrictions on the level of foreign ownership and the implementation of policies favoring local competitors. There may be higher costs associated with these requirements.

For Starbucks, addressing these issues can be done primarily through operations, but there are two major types of financial strategies to address such regulatory risks as well. One concerns the discount rate used to evaluate market attractiveness. For any project that uses a form of discounted cash flow analysis, the discount rate reflects not only the company's weighted average cost of capital but a risk premium. Where there is significant regulatory risk, for example in countries with high levels of corruption and low levels of transparency, the company would adjust the discount rate upward. This could have an effect on the viability of the market entry. For example, a large country like China might be deemed to be worth the risk, but a smaller high-risk country might not have the discounted cash flow to justify the higher risk.

There is also increased regulatory cost in some countries that can affect the decision making. For example, when all of the costs are compiled for a new project or market entry, regulatory costs can diminish the project's expected cash flows considerably. These costs can range from finding ways to mitigate different risks, to the provision of certain employee benefits under local law. Regulatory burden of this type is generally higher in Western nations, but it must be taken into consideration when making a market entry decision.

Tax rules are another area where Starbucks faces regulatory risk. An example would be the recent issues that the company has had in Europe, where regulators are probing to see if the company is paying enough taxes on its various European operations. The company made a point to set up its European businesses in a manner that served to reduce its overall tax burden (Escobales & McVeigh, 2012). Any change in the regulatory regime, either at the UK level or at the EU level, would necessitate further changes to the financial decision making of the company to ensure compliance with the local tax regulations.