MULTINATIONAL ORGANISATIONS

Cultural Differences
when an organisation spans nationalities, cultural differences of a profound sort have to do with national and regional character and have an important bearing on management control According to Hofstede, cultures can differ across four dimensions: power distance individualism/collectivism uncertainty avoidance masculinity/feminity

Cultural Differences
Another classification by Hall differentiates culture on a spectrum from low context e.g. Germany, Britain etc. to high context e.g. Japan Korea etc. Inferences: formal systems used for low context cultures v/s informal controls in high context cultures decentralisation in decisionmaking is more preferred in low power distances

Transfer Pricing
Taxation: Governmental regulations: Tariffs: net effect of tariffs and taxes should be seen in setting transfer prices Foreign exchange controls: some countries limit amount of foreign exchange available to import certain commodities Funds accommodation: Joint ventures: prices fixed for win-win situation

Transfer Pricing
Use of transfer pricing methods: Legal considerations: to minimise taxes, US multinationals transfer assets to low IT countries companies transfer intellectual property rights to low tax country like Ireland Section 482 of Internal Revenue Code, provides rules for determining transfer price on sales between members of controlled group

Transfer Pricing
Acceptable intra-company pricing methods, in descending order of priority are as under: comparable uncontrolled price method: resale price method: cost-plus method: Implications of Section 482: Latitude in transfer prices: in many companies, there is difference between transfer prices for control purposes and legally allowable prices to minimise sum of tax & tariff

Transfer Pricing
management can minimise sum of income taxes and tariffs by maintaining transfer prices as far as possible at appropriate end of the range In the former case, there are two extremes: Some companies permit subsidiaries to deal at arms length and let impact of tax & tariffs fall Foreign transfer prices may be controlled fully by corporate headquarters, for purpose of minimising total corporate costs or obtaining optimum mix of currency positions

Transfer Pricing
Solution to above extremes can be to adjust profits for internal evaluation purposes to reflect competitive market prices many companies that price to minimise taxes and tariffs use same prices for profit budget preparation and reporting as are used for accounting and tax purposes If profit budgets & reports reflect uneconomic prices, care must be taken to make certain that subsidiary managers act in best interests of company

Transfer Pricing
Legal constraints on transfer pricing systems: full cost approach implicit in Section 482 may limit a companys ability to transfer some products at less than full costs companies can use one set of transfer prices for taxation and other for control purposes, to safely adjust subsidiary revenues and costs Minority interests: Top managements flexibility in distribution of profits between subsidiaries gets restricted

Exchange Rates
Multinational Enterprises face translation, transaction and economic exposures to changes in exchange rates exchange rates can be nominal like direct quote or indirect quote e.g. 1 $ = Rs. 45 is an indirect quote for India spot exchange rate is nominal rate on a particular day real exchange rate is spot rate after adjusting for inflation differentials between two countries

Exchange Rates
forward exchange rates are rates known today at which future transactions are done real exchange rates create cost competitiveness changes for a domestic manufacturer against its foreign competitors Different Exchange Rate Exposures: Translation exposure is income statement & balance sheet exposure on MNEs to changes in nominal rates Economic exposure is exposure of firms cash flows to real exchange rate changes

Exchange Rates
Transaction exposure is exposure that a firm has in its cross-border transactions where transactions are entered today but payments for settlement are made at some future date Choice of metric in performance evaluation: in a survey, Choi and Czechowicz found almost all respondents having performance evaluation systems comparing actuals with budget There are three possibilities of metrics: initial exchange rate, projected exchange rate or ending exchange rate (setting and tracking budgets)

Exchange Rates
Favourable cells for setting and tracking budgets include: Initial-initial cell (setting and tracking both) Projected-projected cell (setting and tracking both) Ending-ending cell (setting and tracking both) Initial-ending cell (setting and tracking) Ending-initial cell (setting and tracking) Control System Design issues: should subsidiary managers be responsible for impact of exchange rate fluctuations on their bottom line ?

Exchange Rates
should parent company use home country currency or local currency in performance evaluation ? Further, which type of exchange rate ? should parent company distinguish between effects of different types of exchange rate exposures while evaluating performance of the subsidiary manager ? If yes, how ? how should different exchange rate exposures affect evaluation of economic performance of the subsidiary as distinct from manager in charge of subsidiary ?

Exchange Rates
Translation effects: managers of subsidiaries, who dont have crossborder transactions, need not be concerned with strategic & operating decisions such as pricing and sourcing in response to exchange rate changes subsidiary managers should set and track budgets using same metrics as indicated previously use of translation gains or losses in evaluating subsidiary managers performance could lead to several problems:

Exchange Rates
1. Managers would be made responsible for factors beyond their control 2. It does not get rid of translation gain or loss 3. It will not account for other types of exchange rate exposures faced by subsidiaries 4. It will compound performance of the manager and the subsidiary When companies report to stockholders, they have to consolidate accounting numbers of foreign subsidiaries with numbers of parent

Exchange Rates
Economic exposure: it is appropriate for control system to evaluate subsidiary manager on decisions that would enable subsidiary to respond to real exchange rate changes setting and tracking budgets using different metrics can be unfair for subsidiaries having cross-border transactions, real exchange rate changes require important strategic and operating decisions e.g. importer can drop its local currency prices and increase demand & market share

Exchange Rates
Transaction effects: basic approach is to use appropriate foreign exchange hedging strategies hedging transactions are probably best done at parent company level rather than subsidiaries as: 1. Transaction costs are reduced across hedging 2. Parent company has a better access to wider range of instruments across a greater range of maturities than a subsidiary

Exchange Rates
3. There is no reason to presume that a subsidiary manager can forecast exchange rates any better than corporate treasurer Performance of subsidiary: It is important to recognise that economic performance of subsidiary itself should reflect negative or positive consequences of translation transaction and economic exposures does it make continued economic sense for MNE to carry on operations in that country ? should it take its business elsewhere ?

Exchange Rates
Management considerations: subsidiary managers should not be responsible for translation effects translation effects are best handled by central coordination of MNEs overall hedging needs subsidiary manager should not be responsible for dependence effects of exchange rates resulting from economic exposure Evaluation of subsidiary for decision to locate or relocate operations should reflect consequences of these exposures

Exchange Rates
Management considerations: In a 1982 survey, inconsistencies have been noted in use of metrics for setting & tracking budgets for possibly following reasons: Most of control systems have developed in 1950s and 1960s, when rates were fixed in nature Many companies may not distinguish between financial performance of manager & subsidiary