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International Budgeting and Performance Evaluation


Chapter 14 International Budgeting and Performance Evaluation The Strategic Control Process Four stages of strategic control Periodic strategy reviews for each ... – PowerPoint PPT presentation

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Title: International Budgeting and Performance Evaluation

Chapter 14
  • International Budgeting and Performance Evaluation

The Strategic Control Process
  • Four stages of strategic control
  • Periodic strategy reviews for each business
  • Annual operating plans
  • Formal monitoring of strategic results
  • Personal rewards and central intervention
  • Benefits from a former control process
  • Greater clarity and realism in planning
  • More stretching of performance standards
  • More motivation for business unit managers
  • More timely intervention by central management
  • Clearer responsibilities

The Strategic Control Process
  • Difficult to implement this process in a global
  • Different operating environments include
  • Legal systems
  • Political differences
  • Economic systems (inflation, market size, growth)

Target measures for strategic purposes
  • Return on investment
  • Sales
  • Cost reduction
  • Quality targets
  • Market share
  • Profitability
  • Budget to actual
  • Targets for a unit should be linked to its
    objective and to the part of operations it

Studies of U.S. Multinationals
  • Robbins and Stobaugh (1973) conclusions
  • Tangible and intangible items that entered into
    the original investments calculations were rarely
    taken into account in evaluating the foreign
    subsidiaries performance
  • Foreign subsidiaries were judged on the same
    basis as domestic subsidiaries
  • Most utilized measure of performance for
    subsidiaries was ROI
  • Nearly all multinationals used some supplementary
    measure to evaluate performance
  • Most widely used supplementary measure was
    comparison to budget

Studies of U.K., Japanese Multinationals
  • Appleyard, Strong, and Walton (1990)
  • British companies tend to use budget/actual
    comparisons and ROI
  • British firms use the same ROI measure for all
  • Shields, Chow, Kato, Nakagawa (1991)
  • Japanese companies tend to rely on sales
  • Insert Exhibit 14.2
  • Bailes and Assada (1991)
  • ROI tends to be relatively unimportant to
    Japanese firms

Studies of APEC Multinationals
  • Merchant, Chow, and Wu (1995)
  • Little evidence suggesting a link between
    national culture and firms goals in Taiwan
  • Sample only had 4 firms
  • Kong, Harrison, Harrell (1994)
  • Anglo-American managers prefer short term,
    quantitative objectives
  • Asian firms tend to choose objectives that fit a
    long-term market dominance strategy

Budgeting studies
  • Anglo-American practice
  • Budget process is improved by the participation
    of those who carry out the budget
  • Brownell (1982) for budget participation to
    work, managers must feel like insiders
  • Mexican companies
  • Frucot and Shearon (1991) found a similar
    approach in Mexican companies
  • Insider/outsider dimensions did not matter
  • Mexican managers of foreign owned subs showed
    almost no desire to participate in budgeting

Budgeting studies
  • APEC Multinationals
  • Harrison (1992) found that both Australia and
    Singapore prefer participative style
  • Budgetary participation universally enhances job
    satisfaction regardless of culture
  • Finnish MNE
  • Hassel and Cunningham (1996) found that higher
    exchange of info between headquarters and
    domestic subs increases performance
  • Exchange of info had no effect on foreign subs
  • Market and technology info exchange is a major
    advantage for domestic subsidiaries

Budgeting Studies
  • U.S./Japan Comparisons Bailes and Assada
  • American companies take 12 days longer to prepare
    annual budgets
  • Major objective for U.S. companies is ROI
    Japanese companies focus on sales
  • Division managers participate in budget committee
    discussions more in the U.S.
  • Japanese companies follow a bottom-up approach
    managers wishes are less important than group
  • Japanese managers are more likely to use budget
    variances to recognize problems
  • American managers are more likely to be evaluated
    by the budgets
  • Bonus and salary of American managers are more
    affected by budget performance than those of
    Japanese managers

Budgeting studies
  • U.S./Japan Comparisons
  • Ueno and Sekaran (1992)
  • U.S. budget managers tend to create more slack
  • This behavior is linked to individualism
  • Japanese managers tend to have a long-term focus
    for performance

Budgeting studies
  • Interaction of Culture and Geographic Distance
  • Hassel and Cunningham (2004) findings
  • Subsidiaries with low psychic distance show
    stronger financial performance
  • Psychic distance combination of culture and
    geographic distance
  • Findings suggest that budget controls work most
    effectively for subs that are closer to the
    parent in psychic distance

Planning and Budgeting Issues
  • Currency determination is a major issue
  • After-translation basis is used if the goal is
    to maximize domestic purchasing power
  • Before-translation basis is used if the goal is
    global optimization
  • Local currency is more indicative of the overall
    operating environment
  • Translating budgets into the parent currency
    allows a firm-wide view of the upcoming year

Planning and Budgeting Issues
  • Three approaches in dealing with foreign exchange
    in the budgeting process
  • Allow operating managers to enter into hedge
    contracts with corporate treasury
  • Adjust the actual performance of the unit for
    variations in the real exchange rate after the
    end of the period
  • Adjust performance plans in line with variations
    in the real exchange rate

Ways to Bring Foreign Exchange into the Budgeting
Budgeting and Currency Practices
  • Study of British subs of Japanese firms
  • (Demirag 1994)
  • Companies that indicated that financial
    statements presented in sterling (local currency)
    provided them with better understanding of the
    performance of their companies operations and
    their managementNone of the companies translated
    their profit budgets into yen for performance
    evaluation purposesand none of the parent
    companies sent a copy of the translated yen
  • None of the sub managers were aware of their
    performance in parent currency terms

Capital Budgeting
  • MNEs use sophisticated techniques to forecast
    cash flows, assess risks, and determine the right
    discount rate for NPV
  • Hasan et al. (1997) findings
  • Subs that are majority owned by the parent
    company were more likely to use NPV and IRR
  • Subs that were large, publicly traded, and
    well-established use more complex methods (WACC)
  • Can ROI be used to evaluate individual operations
    and individual managers?

Intracorporate Transfer Pricing
  • Prices should be based on production costs, but
    often are not
  • Companies face the dilemma between complying with
    tax laws and maximizing profits
  • Transfer pricing manipulation can occur
  • Arms length standard is used by tax authorities
    to combat this problem
  • One set of prices for both performance evaluation
    and arms length standards could be used

Intracorporate Transfer Pricing
  • Managers must be careful in this area
  • DHL was fined 60 million for inappropriate
    transfer pricing of intangible assets
  • (Przysuski et. al, 2003)
  • Eden (2001) 3 trends that will play a major
    role in transfer pricing in the coming years
  • Globalization
  • Regionalization
  • The Internet

Matching Price to Market Conditions
Allocation of Overhead
  • Firms must decide what to do with it
  • Example
  • How does IBM, headquartered in New York,
    allocate overhead to its operations in different
    countries? What are the tax implications of this

Cross-Border Allocation of Expenses
  • Differing tax rates complicate the situation
  • Using tax law to allocate overhead can eliminate
    the possibility for a firm to allocate overhead
    based on manufacturing strategy
  • Hiromoto (1988) study of Japan shows that
    Japanese managers are concerned about how
    allocation of costs motivates employees
  • Japanese teach us that overhead is lowered
    permanently only through controllable and highly
    integrated manufacturing processes

Performance Evaluation Issues
  • Gupta and Govindarajan (1991) findings
  • Global innovators and integrated players need
    evaluation systems that are flexible compared to
    implementers or local innovators
  • Global innovators and integrated players rely
    more on behavioral controls and less on output
  • Global innovators need more autonomy than
  • Global innovators rely more on internal control
    of performance than external control

Performance Evaluation Issues
  • No single basis of performance evaluation is
    appropriate for all units of an MNE
  • Multiple bases for performance measurement should
    be used for different operations
  • Must be cost-beneficial
  • Proper measures should eliminate uncontrollable
    impacts due to interdependencies between units

Properly Relating Evaluation to Performance
  • Performance measures can be manipulated
  • Example the ROI income denominator can be
    increased by increasing intracorporate transfer
    prices above the arms length standard
  • Solution compare performance to the plan given
    to the subsidiary
  • Limitations include
  • Illogical and unreasonable plans
  • Managers inputs to plan are bleak so the plan
    can be surpassed

Economic Value Added (EVA)
  • EVA After-tax profit Total cost of capital
  • Measure of the total value added or depleted from
    shareholder value in one period
  • Used primarily for performance evaluation and
    compensation rather than for capital budgets
  • Differences in accounting standards and changing
    currency values can influence EVA
  • Managers should consider the risks to
    international investing to obtain correct costs
    of equity and debt

Economic Value Added (EVA)
  • ROIC Return on invested capital
  • Operating profit minus cash taxes paid
  • by average invested capital
  • WACC Weighted average cost of capital
  • (Net cost of debt debt used)
  • (Net cost of equity equity used)
  • AIC Average invested capital
  • Average stockholders equity average debt

Economic Value Added (EVA)
  • Total revenues 6,500 (million)
  • Total costs 4,000
  • Total operating expenses
  • Cash taxes paid
  • Stockholders Equity (Average)
  • Debt (Average)
  • After-tax cost of debt
  • debt used
  • Cost of Equity
  • equity used
  • Operating Profit 6500 4000 1800 230 470
  • AIC 1,500 2,370 3,870
  • ROIC 470/3,870 12.1
  • WACC (5.5 .40) (15 .60) 11.2
  • EVA (12.1 - 11.2) 3,870 34.83 gt cost of
    capital, value is added

The Balanced Scorecard
  • Developed by Kaplan and Norton (1992)
  • Takes a broader view of performance
  • Bain Co. results (Gumbus and Lyons 2002)
  • 50 of Fortune 1,000 North American companies use
    the balanced scorecard
  • 40 of European companies use a version of the
  • Perspectives in the scorecard include
  • Financial
  • Customer
  • Internal business processes
  • Learning and growth

(No Transcript)
The Balanced Scorecard
  • IKEA uses the BSC approach, as does Philips
  • Adequate use of the BSC
  • Helps managers avoid using only one performance
  • Forces managers to link financial measures with
    the non-financial factors that drive them
  • Ensures that subs are evaluated based on a
    coherent set of performance bases
  • Insert Exhibit 14.10
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