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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
The Strategic Control Process


Difficult to implement this process in a global
environment
Different operating environments include



Legal systems
Political differences
Economic systems (inflation, market size, growth)
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 controls
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Studies of U.K., Japanese
Multinationals

Appleyard, Strong, and Walton (1990)



Shields, Chow, Kato, Nakagawa (1991)



British companies tend to use budget/actual comparisons
and ROI
British firms use the same ROI measure for all subsidiaries
Japanese companies tend to rely on sales
Insert Exhibit 14.2
Bailes and Assada (1991)

ROI tends to be relatively unimportant to Japanese firms
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Studies of APEC
Multinationals

Merchant, Chow, and Wu (1995)



Kong, Harrison, Harrell (1994)


Little evidence suggesting a link between national
culture and firms’ goals in Taiwan
Sample only had 4 firms
Anglo-American managers prefer short term,
quantitative objectives
Asian firms tend to choose objectives that fit
a long-term market dominance strategy
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 consensus
 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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Ways to Bring Foreign Exchange
into the Budgeting Process
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
management…None of the companies translated their profit
budgets into yen for performance evaluation purposes…[and]
none of the parent companies sent a copy of the translated yen
statements.”
None of the sub managers were aware of their performance in
parent currency terms
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 wellestablished use more complex methods (WACC)
Can ROI be used to evaluate individual
operations and individual managers?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
Arm’s length standard is used by tax authorities to
combat this problem
One set of prices for both performance evaluation
and arm’s length standards could be used
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Matching Price to Market
Conditions
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 issue?

International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
controls
Global innovators need more autonomy than
implementers
Global innovators rely more on internal control of
performance than external control
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 arm’s 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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Economic Value Added (EVA)
EVA = [ROIC – WACC] * AIC
ROIC = Return on invested capital
= Operating profit minus cash taxes paid divided
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
Economic Value Added (EVA)
Total revenues
Total costs
Total operating expenses
Cash taxes paid
Stockholders Equity (Average)
Debt (Average)
After-tax cost of debt
% debt used
Cost of Equity
% equity used
$6,500 (million)
4,000
1,800
230
1,500
2,370
5.5%
40%
15%
60%
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 > cost of capital, value is added
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
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 BSC
Perspectives in the scorecard include




Financial
Customer
Internal business processes
Learning and growth
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black
The Balanced Scorecard


IKEA uses the BSC approach, as does
Philips
Adequate use of the BSC




Helps managers avoid using only one
performance measure
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black