1. International Budgeting and Performance Evaluation
Chapter 14
International Budgeting and Performance Evaluation

2. 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
Gupta and Govindarajan (1991) – where does this go?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

3. 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)
Citation needed here?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

4. 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

5. 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

6. 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 subsidiaries
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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

7. 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
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

8. Budgeting studies Anglo-American practice Mexican companies
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
Need a citation for the second bullet?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

9. Budgeting studies APEC Multinationals Finnish MNE
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

10. 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
Get the year of this study!
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

11. 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

12. 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

13. 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

14. 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
Citation needed here?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

15. Ways to Bring Foreign Exchange into the Budgeting Process
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

16. 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
Does bolded piece need quotation marks?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

17. 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?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

18. 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
(Eden 2001)
Baldenius (2004)
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

19. 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
Is first citation correct
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

20. Matching Price to Market Conditions
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

21. 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?
Citation needed?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

22. 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
Fourth bullet cited or indented?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

23. 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
“or local innovators?”
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

24. 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

25. 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
Citation needed for example?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

26. 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

27. 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

28. Economic Value Added (EVA)
Total revenues $6,500 (million)
Total costs ,000
Total operating expenses ,800
Cash taxes paid
Stockholders Equity (Average) ,500
Debt (Average) ,370
After-tax cost of debt %
% debt used %
Cost of Equity %
% equity used %
Operating Profit = 6500 – 4000 – 1800 – 230 = 470
AIC = 1, ,370 = 3,870
ROIC = 470/3,870 = 12.1%
WACC = (5.5% *.40) + (15% +.60) = 11.2%
EVA = (12.1% %) * 3,870 = > cost of capital, value is added
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

29. 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

30. International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black

31. 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
Any citations needed?
International Accounting & Multinational Enterprises – Chapter 14 – Radebaugh, Gray, Black