10. Methodology of enterprise groups ESTP Course on the EGR 3-4-5 December 2014 10. Methodology of enterprise groups

Multinational enterprise groups Economic aspects Evolutionary stages Activities Organisation and governance Behaviours Statistical aspects Statistical representation Derivation of groups structures Representation in EGR EGR: economic delineation of the groups and the methodology of profiling Barilla has plants and offices in Greece, France, Germany, Norway, Russia, Sweden, Turkey, US, and Mexico. Wheat is purchased from around the world. EGR: statistical delineation of the groups and the methodology of consolidation

Economic aspects

Main facts Capital is much more mobile than labour Countries where costs of labour are lower Location of raw material inputs Transports costs are relatively lower Communication technology boom Enterprises need to growth Sell and offer after selling services Location in different countries Often multinational groups are criticized to runaway activities

Economic definition One possible definition, according to Franklin Root (1994): A multinational group is characterised by the fact that there is 'a parent company' that: engages in foreign production through its affiliates located in several countries, exercises control over the policies of its affiliates, and implements transnational business strategies in production, marketing, finance and staffing that transcend national boundaries.

Evolutionary stages of the multinational groups Export Stage Foreign production stage Multinational Stage

I – Export stage Only export – initial demand Network of export agents - expansion of export Foreign sales branch or assembly operations - save transport cost

II – Foreign Direct Investment stage There are economic limit to foreign exports (tariffs, quotas and transport costs) Environmental factors laws, regulations, access to credit, public services, infrastructures, raw materials Market factors Meet consumer demands on the markets, provide assistance and post sales services, etc. Economic factors Lower labour costs, no exchange rate fluctuations,

III – Multinational Stage Production is switched from the parent producers to its legally independent affiliates or subsidiaries Strategic financial and economic control is centralised Subsidiaries not pop up randomly in foreign nations Decision of top management Critical step in growth strategies Risks (uncertainty, lack of information, …) Large investment Investment go from countries where profits are expected to be low to countries with high expected returns

Exports versus FDI Foreign production is not always an answer Foreign markets can be better served by exporting, rather than by creating a foreign subsidiary if there are economies of scale If large scale production reduces unit cost, it is better to concentrate production in one place If there exists excess of domestic productive capacity, there is no point in creating another plant abroad Multinational groups always have large external trade flows

Objectives and market orientation The economic objective is global profit maximization However, most multinational groups are either: home country oriented host country oriented Depending on the production/products types Only some are world-oriented, but must adapt to local markets and this requires a very large and complex organisation

Organisation and governance Organisation: legal, regulatory, institutional and ethical environment of the multinational group Governance: “how investors get the managers to give them back their money” Governance determines who has power and makes decisions Both terms address the concept of control The board of directors is typically central to the governance Its relationship to the other primary participants, typically shareholders and management, is critical Additional participants to governance include employees, customers, suppliers, and creditors.

Joint Ventures Two or more companies that divide control to: Conduct activities in a third country Conduct activities with a local company Joint venture may includes local government Because: Costs are too high for a single company Local governments request The new company is able to enter the market that neither parent could have entered singly Increase market power

Taxation Operating in many countries, MNCs are subject to multiple tax jurisdictions, i.e., they must pay taxes to several countries Multiple Tax Jurisdictions create two problems: Overlapping jurisdictions Two or more governments claim tax jurisdictions over the same income and it may result in double taxation Underlapping jurisdiction Tax evasion Since countries have different tax rates, multinational companies choose low tax countries to save, invest, and produce. Governments may compete to attract multinational enterprises by offering them lower tax rates and other incentives. This is called tax competition. Since high tax countries lose lucrative businesses, they want to harmonize tax rates, especially within a free trade area or customs union (e.g., European Community).

Transfer prices Differences among national income tax systems affect the decisions regarding the location of subsidiaries, financing, and the transfer prices Transfer prices are the prices paid for imports/exports between legal units in the same multinational group Multinational groups manipulate such prices so that profits are highest in the low tax country Purpose: to minimize the total tax a multinational groups pays. Abuses in pricing across national borders are illegal and tax authorities try to identify them, but it is difficult to prove

Conclusions For defining the economic aspects of the multinational enterprise groups it is necessary to understand: Where the groups' affiliates are located What activities are carried out in the different countries What is the organisation How is the governance (who has global control) All about intra-group transactions (products, values, countries, prices, …) ……….

Statistical aspects

Statistical representation (1) 1. As a simple set of legal units bounched together 2. As a set of enterprises carring out economic activity Legal Unit 1 Legal Unit 2 Legal Unit n    Enterprise Group Enterprise 1 Enterprise 2 Enterprise n    Enterprise Group

Statistical representation (2) 3. As a complete structure of legal units and their controlling relationships and the economic enterprises Enterprise Group Enterprise 1 Enterprise 4 Enterprise 2 Enterprise 3 Enterprise 5 Head of Group A LEU E LEU D LEU C LEU B LEU F LEU G LEU I LEU H LEU J LEU K

Information Data sources Ownership shares (A owns X% of B) Voting rights (A has (X-Y)% voting rights on B) Economic activity Economic characteristics Global/Unique Identifiers Administrative sources Annual Reports Commercial sources Statistical sources Direct information Web information

Operational criteria for control (1) Source: Business Registers Recommendation Manual - Eurostat 1) A legal unit directly owns more than 50 % of the voting rights of another legal unit (direct control); 2) A legal unit indirectly owns more than 50 % of the voting rights of another legal unit, through subsidiaries (indirect control); 3) Existence of special legislation decree or regulation, which empowers the government to determine corporate policy or to appoint the directors of the legal unit;

Operational criteria for control (2) 4) A legal unit fully consolidates the accounts of another legal unit, according to the criteria of the Seventh Directive, and no other legal unit consolidates the same legal unit (control by virtue of full consolidation); 5) Administrative sources, collecting declarations in application of specific laws for market regulation, provide the information that a legal unit controls one or a set of legal units, even though it owns less or 50 % of its voting rights (effective minority control) and no other legal unit owns more. Note — It may be possible that two rules, e.g. both cases 1 and 4, could apply simultaneously. As one unit cannot be controlled by two different units, the de facto controlling unit should then be chosen. Case 4 can in general be considered as weaker than 1, because there can be consolidation situations with less than 50% ownership and situations with over 50% ownership without consolidation.

From shares…

…to control

Concepts of GGH UCI GDC GGH: one legal unit at the top of the control which is not controlled by any other legal unit and which controls all other legal units in the hierarchy UCI:Ultimate controlling institutional unit of a foreign affiliate” shall mean the institutional unit, proceeding up a foreign affiliate’s chain of control, which is not controlled by another institutional unit GDC: The global decision centre is the unit where the strategic decisions of an enterprise group are taken In most of the cases the global decision centre equals to the global group head

Special cases Four types of special cases are defined, where the definition of the global decision centre/UCI requires special treatment 1) Natural persons and families 2) Units located in tax havens, in offshore financial centres, special purpose entities, non-profit institutions 3) Dual listed companies 4) Joint ventures The starting point is always the GGH If the GGH is one of the 4 cases, other units downward in the chain should be examined and appointed as the global decision centre/UCI

Implementation of 'control' in EGR Control by means of a single relationship: ‘Type of ownership’ = ‘I'(ndirect)’ ‘Type of ownership’ = ‘D(irect)’ and voting power > 50%)   Control by means of ‘cumulative’ shares: B and C both have a non-controlling direct relationship with D, but B and C both are subsidiaries of A and A thus has cumulative control on D (See next example).

Implementation of GGH UCI/GDC GGH assigned by default by reconstructing the whole chain of control The UCI used by FATS statistics is considered the same concept as the GDC If the GGH is not the GDC it has to be manually assigned by profilers or by FATS users

Finding GDC, a very complex task… According to some major world-wide publications: Wall-Mart Exxon Mobil Royal dutch Shell BP Toyota Chevron ING Total General Motors ConocoPhillips Are U.S. ultimately and globally controlled…

Conclusion For getting to a statistical representation of the groups it is necessary to understand: What is the statistical purpose Which basic information is needed and where can be found What is the logical model for representing a group What algorithm do we have to perform to build up the physical structure of the groups What quality level is needed for the statistical purpose Statistical Units, Characteristics, Timeliness of frames, … How to validate the characteristics of a group relevant for the statistical purpose

Thanks for your attention Questions? enrica.morganti@ec.europa.eu