5 (Solution note: The following answer for question 5(a) is indicative. Credit will be given for alternative suggestions of risks and
issues, and their management or control.)
(a) Kilenc Co needs to consider a number of risks and issues when making the decision about whether or not to set up a
subsidiary company in Lanosia. It should then consider how these may be managed or controlled.
Key Risks/Issues
Kilenc Co needs to assess the impact on its current exports to Lanosia and the nearby countries if the subsidiary is set up.
Presumably, products are currently exported to these countries and if these exports stop, then there may be a negative impact
on the employees and facilities currently employed in this area. Related to this may be the risk of loss of reputation if the
move results in redundancies. Furthermore, Kilenc Co should consider how the subsidiary and its products would be seen in
Lanosia and the nearby countries. For example, would the locally made products be perceived as being of comparative quality
as the imported products?
The recession in Lanosia may have a negative impact on the market for the products. The cost of setting up the subsidiary
company needs to be compared with the benefits from extra sales revenue and reduced costs. There is a risk that the
perceived benefits may be less than predicted or the establishment of a subsidiary may create opportunities in the future once
the country recovers from the recession.
Currently the government offers support for companies involved in the pharmaceutical industry. Kilenc Co may find it difficult
to set up the subsidiary if it is viewed as impeding the development of the local industry by the government. For example,
the government may impose restrictions or increase the taxes the subsidiary may have to pay. On the other hand, the
subsidiary may be viewed as supporting the economy and the growth of the pharmaceutical industry, especially since 40%
of the shares and 50% of the Board of Directors would be in local hands. The government may even offer the same support
as it currently offers the other local companies.
20Kilenc Co wants to finance the subsidiary through a mixture of equity and debt. The implications of raising equity finance are
discussed in part (b) of the question. However, the risks surrounding debt finance needs further discussion. Raising debt
finance in Lanosia would match the income generated in Lanosia with debt interest payments, but the company needs to
consider whether or not it would be possible to borrow the money. Given that the government has had to finance the banks
may mean that the availability of funds to borrow may be limited. Also interest rates are low at the moment but inflation is
high, this may result in pressure on the government to raise interest rates in the future. The consequences of this may be that
the borrowing costs increase for Kilenc Co.
The composition of the Board of Directors and the large proportion of the subsidiary’s equity held by minority shareholders
may create agency issues and risks. Kilenc Co may find that the subsidiary’s Board may make decisions which are not in the
interests of the parent company, or that the shareholders attempt to move the subsidiary in a direction which is not in the
interests of the parent company. On the other hand, the subsidiary’s Board may feel that the parent company is imposing too
many restrictions on its ability to operate independently and the minority shareholders may feel that their interests are not
being considered by the parent company.
Kilenc Co needs to consider the cultural issues when setting up a subsidiary in another country. These may range from cultural
issues of different nationalities and doing business in the country to cultural issues within the organisation. Communication
of how the company is organised and understanding of cultural issues is very important in this case. The balance between
independent autonomy and central control needs to be established and agreed.
Risks such as foreign exchange exposure, product health and safety compliance, employee health and safety regulations and
physical risks need to be considered and assessed. For example, foreign exchange exposures arising from exporting the
products to nearby countries need to be assessed. The legal requirements around product health and safety and employee
health and safety need to be understood and complied with. Risks of physical damage such as from floods or fires on the
assets of the business need to be established.
Mitigating the Risks and Issues
A full analysis of the financial costs and benefits should be undertaken to establish the viability of setting up the subsidiary.
Sensitivity and probability analysis should be undertaken to assess the impact and possibility of falling revenues and rising
costs. Analysis of real options should be undertaken to establish the value of possible follow-on projects.
Effective marketing communication such as media advertising should be conducted on the products produced by the
subsidiary to ensure that the customers’ perceptions of the new products do not change. This could be supported by retaining
the packaging of the products. Internal and external communication should explain the consequences of any negative impact
of the move to Lanosia to minimise any reputational damage. Where possible, employees should be redeployed to other
divisions, in order to minimise any negative disruption.
Negotiations with the Lanosian government should be undertaken regularly during the process of setting up the subsidiary to
minimise any restrictions and to maximise any benefits such as favourable tax rates. Where necessary and possible, these
may be augmented with appropriate insurance and legal advice. Continuing lobbying may also be necessary after the
subsidiary has been established to reduce the possibility of new rules and regulations which may be detrimental to the
subsidiary’s business.
An economic analysis may be conducted on the likely movements in inflation and interest rates. Kilenc Co may also want to
look into using fixed rate debt for its long-term financing needs, or use swaps to change from variable rates to fixed rates. The
costs of such activity need to be taken into account.
Clear corporate governance mechanisms need to be negotiated and agreed on, to strike a balance between central control
and subsidiary autonomy. The negotiations should involve the major parties and legal advice may be sought where necessary.
These mechanisms should be clearly communicated to the major parties.
The subsidiary organisation should be set up to take account of cultural differences where possible. Induction sessions for
employees and staff handbooks can be used to communicate the culture of the organisation and how to work within the
organisation.
Foreign exchange exposure, health and safety regulation and risk of physical loss can be managed by a combination of
hedging, insurance and legal advice.
(b) Dark pool trading systems allow share orders to be placed and matched without the traders’ interests being declared publicly
on the normal stock exchange. Therefore the price of these trades is determined anonymously and the trade is only declared
publicly after it has been agreed. Large volume trades which use dark pool trading systems prevent signals reaching the
markets in order to minimise large fluctuations in the share price or the markets moving against them.
The main argument put forward in support of dark pool trading systems is that by preventing large movements in the share
price due to volume sales, the markets’ artificial price volatility would be reduced and the markets maintain their efficiency.
The contrary arguments suggest that in fact market efficiency is reduced by dark pool trading systems because such trades
do not contribute to the price changes. Furthermore, because most of the individuals who use the markets to trade equity
shares are not aware of the trade, transparency is reduced. This, in turn, reduces the liquidity in the markets and therefore
may compromise their efficiency. The ultimate danger is that the lack of transparency and liquidity may result in an
uncontrolled spread of risks similar to what led to the recent global financial crisis.
21It is unlikely that the dark pool trading systems would have an impact on Kilenc Co’s subsidiary company because the
subsidiary’s share price would be based on Kilenc Co’s share price and would not be affected by the stock market in Lanosia.
Market efficiency in general in Lanosia would probably be much more important.
