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

environment
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 controls

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)

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

Studies of APEC Multinationals

Merchant,

Little evidence suggesting a link between national

culture and firms goals in Taiwan
Sample only had 4 firms

Kong,

Chow, and Wu (1995)

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 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

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 Process

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 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

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?

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 issue?

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 controls
Global innovators need more autonomy than
implementers
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)

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

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

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

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