Roadmap

Cross Border Issues in CoDE

1. Foreign Market Entry: Motives and Strategy
2. Selected Issues:
   1. Failure
   2. Currency Conversion
   3. Policy Uncertainty
   4. Tariffs

Relevant Learning Goals

Cross Border Issues in CoDE

What Motivates Firms To Acquire a Firm in Another Country?

Menti-Results

Motivation

Cross Border Issues in CoDE

“Such factors include differences in economic development, laws, institutions, culture, labor rights, protection of intellectual property, taxes, and corporate governance”

Erel, Jang, and Weisbach (2022)

Motivation

Cross Border Issues in CoDE (DePamphilis 2025)

Market Entry Strategy

Cross Border Issues in CoDE (DePamphilis 2025)

“[…] market entry chosen by a firm may reflect the firm’s risk tolerance, competitive conditions, overall resources, and degree of CEO overconfidence. Common entry strategies include M&As, solo ventures, joint ventures, export, and licensing.”

DePamphilis (2025)

Solo Venture?

Cross Border Issues in CoDE

In a solo venture (Greenfield Investment) a parent company establishes new business operations (e.g., subsidiary or branch) in a foreign country (foreign direct investment) from scratch. These new operations can include facilities, offices, and employees, in contrast to situations where the parent intends buying or partnering with an existing business.

Greenfield Investment

Cross Border Issues in CoDE

Failure

From Motivation, to Strategy, to Success?

Cross-border M&As often are perceived as much more risky than domestic deals

Why?

• Cultural Differences

• Regulatory Complexity

• Currency Risk

• […]?

Failure

From Motivation, to Strategy, to Success?

Notes

Cultural Differences:

• Organizational culture conflicts
• National cultural differences affecting management styles
• Language barriers complicating both negotiation and integration
• Example: Differences in directness of communication or attitudes toward hierarchy

Failure

From Motivation, to Strategy, to Success?

Notes

Regulatory Complexity:

• Multiple regulatory regimes to navigate simultaneously
• Antitrust/competition law differences across jurisdictions
• Employment law variations affecting integration planning
• Example: EU labor protections versus more “flexible” employment in the US

Failure

From Motivation, to Strategy, to Success?

Notes

Currency Risk:

• Exchange rate fluctuations between deal signing and closing
• Long-term currency trends affecting the value of the investment
• Potential currency conversion restrictions in some markets
• Example: Significant devaluations affecting the actual cost of acquisition or post-acquisition returns

Add:

• Tax, Information Asymmetry (Governance), Litigation, Trade Secrecy, Rule of Law …

Daimler-Chrysler Case Study

Cross Border Issues in CoDE: Failure

Daimler-Chrysler

Failure

• Daimler sold Chrysler in 2007 for USD 7.4 billion (effectively way less)

• Seen as a textbook failure in international M&A execution

What happened?

Daimler-Chrysler

Failure

Daimler-Chrysler

Failure

Beyond Financials

Failure

Cultural Clash?

But what isn’t practiced, and too often ignored, is the process of asking: “What are the likely challenges we will face as we integrate these two complex companies over the next 1-2 years?”

Fubini (2014)

Beyond Financials

Failure

Key Steps

• Assess Institutional Strengths

• Understand Cultural Dynamics

• Doing a stakeholder analysis to understand the additional challenges from political, regulatory, union, and community sources to be expected

How Detrimental Are Failed Mergers?

Failed Mergers Revisited

Innovation

“[…] relative to failed targets, firms acquired in diversifying mergers produce both a smaller number of innovations and also less-novel innovations, where innovations are measured using patent-based metrics.”

Seru (2014)

How Detrimental Are Failed Mergers?

Failed Mergers Revisited: Seru (2014)

• Research Question: How does the conglomerate form (established through M&A) affect innovation?

• Identification: treatment: targets taken over in friendly mergers; control: targets whose mergers failed to go through

• Theory/Tension: conglomerates may accelerate at directing investments but such internal capital markets also come with substantial information asymmetries between researchers & managers

• Finding: firms in treatment group face a significant decline in novelty of their research

→ challenges the conventional assumption (?) that mergers enhance capabilities

How Detrimental Are Failed Mergers?

Failed Mergers Revisited: Seru (2014)

Notes

Implications:

• Companies that are acquisition targets but where deals fell through may actually perform better on innovation metrics than those that are acquired
• This suggests mergers can sometimes disrupt valuable innovation processes
• The paper specifically looks at patent quantity and quality as innovation metrics

How Detrimental Are Failed Mergers?

Failed Mergers Revisited: Seru (2014)

Notes

Specific Mergers: The focus is on “diversifying mergers” specifically (where acquirer and target are in different industries), not all mergers.

Identification Strategy: Failed mergers establish the “control group” to isolate the effects of being acquired, addressing the challenge that acquisition targets aren’t randomly selected.

Foreign Target Cash Flows

Cross Border Issues in CoDE

Task

Converting foreign target cash flows to acquirer domestic cash flows (assume: USD acquirer & EUR target)

Approach

Predict forward (future spot) exchange rates based on interest rate parity (IRP) or purchasing power parity (PPP) theories

Interest Rate Parity Theory

Convert Foreign Target Cash Flows

Why Do We Need a Theory? Example

Interest Rate Parity Theory

Assume that you (U.S.) have $10M to invest, and that interest rates in the U.S. and the U.K. are 8% and 12%, respectively. The current spot exchange rate is $1.60/£ (the current number of dollars required to buy one Pound), and the one-year forward exchange rate is $1.53/£.

Where should you invest your money?

Why Do We Need a Theory?

Interest Rate Parity Theory

Example cont’d

• Under these assumptions, arbitrage opportunities exist!

  • Borrow Pounds (e.g. £1m) at 12% interest rate in the U.K. = £1.12m

  • Convert to dollars at the spot rate: £1m × ($1.60/£) = $1.6m

  • Invest at home interest rate: $1.6m × 1.08 = $1.728m

  • Convert back at forward rate: $1.728m ÷ ($1.53/£) = £1.129m

Why Do We Need a Theory?

Interest Rate Parity Theory

Example cont’d

“There’s no free lunch.”

Interest Rate Parity Theory

Convert Foreign Target Cash Flows

Core Principle

The forward exchange rate should offset interest rate differences, making investors indifferent between countries

Interest Rate Parity Theory

Convert Foreign Target Cash Flows

Interest Rate Parity Theory

Notes

Notes (from DePamphilis (2025)):

For developed nations, the interest rate parity theory provides a framework for estimating forward currency exchange rates (i.e., future spot exchange rates). According to this theory, the percentage difference in the forward rate relative to the spot rate should be approximately equal to the difference in interest rates. If true, investors should not be able to profit from differences in interest rates because the forward rate should be set so that an investor would be indifferent between investing in the two different countries once the investor translates the profit back into his/her home currency.

Interest Rate Parity Theory

Notes

Notes (from DePamphilis (2025)):

For example, if U.S. interest rates rise relative to those in the EU, investors will buy dollars with euros at the current spot rate and sell an equivalent amount dollars for euros in the forward market t periods in anticipation of receiving the proceeds of their investment at maturity. At that time, these investors will convert the proceeds from dollars to Euros. These actions cause the Dollar/Euro spot rate to fall (i.e., the dollar appreciates in the spot market due to the increased supply of Euros offered to buy dollars) and the Dollar/Euro forward rate to rise (USD/EUR)_t (S_t) (i.e., the dollar depreciates in the forward market due to the increased supply of dollars offered to buy euros). The spot rate will appreciate and forward rate depreciate until the profit derived from the interest rate difference is erased. At that point, investors should be indifferent between investing in the U.S. and Eurozone countries.

Interest Rate Parity Theory

Notes

Notes (from DePamphilis (2025)):

In practice, equilibrium between forward exchange rates and spot rates adjusted for the ratio of interest rates in the U.S. to those in Eurozone countries will be restored by a combination of an appreciating dollar-to-Euro spot exchange rates, depreciating dollar-to-Euro forward rates(, declining U.S. interest rates, and increasing interest rates in Eurozone countries. Interest rates on U.S. bids will decline as the investors bid up their prices and interest rates on Eurozone bonds of comparable risk and maturity will increase as investors sell these bonds and invest the proceeds in the U.S).

Interest Rate Parity Theory

Convert Foreign Target Cash Flows

\[ \begin{aligned} \frac{S_t}{S_0} &= \frac{(1 + i_{\$t})^t}{(1 + i_{€t})^t} \\ \\ S_t &= S_0 \times \frac{(1 + i_{\$t})^t}{(1 + i_{€t})^t} \\ \end{aligned} \]

\[ \begin{aligned} \text{Where } S_t &= \text{Forward/projected USD/EUR exchange rate $t$ periods into the future} \\ S_0 &= \text{current USD/EUR spot rate} \\ i_{\$t} &= \text{Interest rate in US (domestic) in $t$} \\ i_{€t} &= \text{Interest rate in European Union (foreign) in $t$} \end{aligned} \]

Example

Interest Rate Parity Theory

Case

A US acquirer is evaluating the projected cash flows of a foreign acquisition target. The target firm is expected to generate Free Cash Flow to the Firm (FCFF) ranging from 124.5 to 145 EUR over the next four years. To convert these into USD, Interest Rate Parity is applied using the forecasted domestic (i.e., US) interest rates ranging from 4.25% to 4.55% and foreign interest rates ranging from 4.0% to 5.3%. The current spot exchange rate is 1.2044 USD/EUR.

Example

Interest Rate Parity Theory

• Calculate (i) projected/forward spot rates and (ii) FCFF in USD for years 1-4

• How and why do the current spot rate and the projected spot rate in year 1 differ?

Your Turn!

Example

Interest Rate Parity Theory

Projected Spot Rate

\[ S_t = S_0 \cdot \left( \frac{1 + i_{domestic}}{1 + i_{foreign}} \right)^t \]

Where:

• \(S_t\) = Projected spot rate in year t
• \(S_0\) = Current spot rate = 1.2044
• \(i_{domestic}\) = US interest rate in year t
  
• \(i_{foreign}\) = Foreign country interest rate in year t

Example

Interest Rate Parity Theory

Year 1

\[ \begin{aligned} S_1 = 1.2044 \cdot \left( \frac{1.0425}{1.045} \right)^1 \\ \\ S_1 = 1.2015 \end{aligned} \]

1.2044 ≠ 1.2015 (?)

• Projected rate at \(S_1\) includes the effect of one year of interest rate differential → \(S_0\) ≠ \(S_1\)

• Unless the domestic and foreign interest rates are exactly equal, \(S_1\) will deviate from the \(S_0\)

Example

Interest Rate Parity Theory

Year 1

\[ \begin{aligned} \text{FCFF}_\text{USD} = \text{FCFF}_\text{Target} \cdot S_t \\ \\ FCFF_{USD1} = 124.5 \cdot 1.2015 \\ \\ FCFF_{USD1} = 149.59 \end{aligned} \]

Example

Interest Rate Parity Theory

Years 1-4

library(tidyverse)

# FUNCTION 
project_fcff_usd <- function(df, current_spot_rate) {

  # message
  print("Projecting Free Cash Flow to the Firm (FCFF) in USD using Interest Rate Parity (IRP)")
  print("assuming that current spot rate is given in USD/FOREIGN")

  # Ensure data is sorted by year
  df <- df[order(df$Year), ]
  
  # Initialize columns
  df$ProjectedSpotRate <- NA
  df$FCFF_USD <- NA
  
  # Calculate projected spot rates 
    for (i in 1:nrow(df)) {
    # Time step
    t <- i
    # IRP formula with compounding
    df$ProjectedSpotRate[i] <- current_spot_rate *
      (((1 + df$Interest_Domestic[i])^t) / ((1 + df$Interest_Foreign[i])^t))
  }

  # Calculate FCFF in USD
  df$FCFF_USD <- df$FCFF_Target * df$ProjectedSpotRate

return(df)

}


# EXAMPLE DATA
example_df <- data.frame(
  Year = 1:4,
  FCFF_Target = c(124.5, 130.7, 136.0, 145),
  Interest_Foreign = c(0.045, 0.047, 0.053, 0.04),
  Interest_Domestic = c(0.0425, 0.0435, 0.0455, 0.042)  
)

# CURRENT SPOT RATE
current_spot_rate <- 1.2044

# APPLY FUNCTION
project_fcff_usd(df = example_df, current_spot_rate)

USD/EUR Spot Rates Over Time

Interest Rate Parity Theory

Currency Conversion

• USD/EUR spot rate for us is the current number of dollars required to buy one Euro
• Increasing USD/EUR spot rate: during your trip to New York City, buying a T-Shirt with your Dutch debit card becomes cheaper

USD/EUR Spot Rates since 2025

Interest Rate Parity Theory

Policy Uncertainty

Cross Border Issues in CoDE

Definition

(Economic) policy uncertainty refers to uncertainty about who will make economic policy decisions, what economic policy actions will be undertaken and when, and the economic effects of those actions (or inaction)

Baker, Bloom, and Davis (2016)

Policy Uncertainty

Cross Border Issues in CoDE

Bringing our Definition to Life

“Examples of political and economic risk include excessive local government regulation, confiscatory tax policies, restrictions on cash remittances, currency inconvertibility, restrictive employment policies, expropriation of assets of foreign firms, civil war or local insurgencies, and corruption.”

DePamphilis (2025)

Does Policy Uncertainty Affect Mergers and Acquisitions?

Policy Uncertainty & M&A

“Political and regulatory uncertainty is strongly negatively associated with merger and acquisition activity at the macro and firm levels.”

Bonaime, Gulen, and Ion (2018)

→ Let’s reconsider: why should it?

→ How can we confidently derive at this conclusion?

Policy Uncertainty & Mergers and Acquisitions

Why?

Theory in Bonaime, Gulen, and Ion (2018)

• Risk Management (+): an increase in uncertainty encourages managers to operationally hedge via vertical integration (some evidence)

• Empire Building (+): exploit uncertainty for managers’ personal agendas while investor attention is low (not supported)

• Interim Risk (-): target value could change between announcement and deal completion (not supported)

• Real option theory (-): uncertainty increases the value of waiting to invest (strong empirical evidence) → fits intuitively to downside risks highlighted in DePamphilis (2025)

Definition Real Option

Real Option Theory in M&A

Applications in Practice?

“[…] many companies hesitate to apply options theory to initiatives such as R&D and geographic expansion, partly because these real options are highly complex.”

Copeland and Tufano (2004)

→ Copeland and Tufano (2004) (available at HBR Online) suggest a decision/event tree implementation More

Measuring Policy Uncertainty

How?

“We develop a new index of economic policy uncertainty (EPU) based on newspaper coverage frequency. Several types of evidence—including human readings of 12,000 newspaper articles—indicate that our index proxies for movements in policy-related economic uncertainty.”

Baker, Bloom, and Davis (2016)

PolicyUncertainty.com

Measuring Policy Uncertainty

Baker, Bloom, and Davis (2016)

Macro EPU

• Substantial (recent) movement in uncertainty
• Graph: Trade Policy Uncertainty (tariffs are up next)
• Hassan et al. (2017) take measure from macro to firm-level

More on Policy Uncertainty Effects

Cross Border Issues in CoDE

Alternative Measures & Identification Strategies

• Gallemore et al. (2025): “tax policy uncertainty can impact investment behavior”

• Cao, Li, and Liu (2019): “when a country is about to hold a national election, this deters foreign firms’ inbound acquisitions, especially when the host country poses greater expropriation risk.”

• […]!

Policy Uncertainty ?

(Tax) Incentive Shopping

“In regimes with strict nexus requirements, reduced taxation of IP income is associated with reductions in the number of deals and the probability of being acquired for patent-owning firms due to the potential loss of eligibility for preferential taxation. This effect dissipates where nexus requirements are relaxed, and significant positive effects of IP box tax savings in more permissive regimes point to increased after-tax valuations of merger-driven synergies”

Bradley, Robinson, and Ruf (2021)

Tariffs

Cross Border Issues in CoDE

“[…] one component of trade costs, tariffs, can actually be a reason for making a cross-border acquisition”

Erel, Jang, and Weisbach (2022)

Why?

→ when tariffs are sufficiently high, firms will make cross border acquisitions or greenfield investments to avoid paying them

→ but! avoiding tariffs through FDI has been restricted by the CJEU lately

Tariffs

Cross Border Issues in CoDE

Tariffs

Cross Border Issues in CoDE

Statutory Incidence

“The costs of purchase of inventories comprise the purchase price, import duties and other taxes […]” (IAS 2)

Tariffs

Cross Border Issues in CoDE

Economic Incidence

Economic incidence (e.g., of a tariff) differs from statutory incidence (here importer) when passed through to others (e.g., customers)

Summary

Cross Border Issues in CoDE

Thank You!

Real Option Theory

Copeland and Tufano (2004)

• A firm’s projects (e.g., research and development, investments in new capacity, geographical expansion, and other initiatives) are seldom simple onetime decisions; in most cases, a company’s investments are multistaged, and at each step the company may push ahead or pull out after gaining new information.

• These projects are thus real options (for financial options, see Black and Scholes (1973)): the right but not the obligation to invest

Back

Real Option Theory

Copeland and Tufano (2004)

Event Tree

1. Estimating what the value of the project would be if it existed today, a figure that may be derived from traditional non-option valuation techniques, such as discounted cash flow

2. The second step is estimating how much this value is likely to move up or down during the period in question

→ example? see Copeland and Tufano (2004)

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