Performance evaluation

Pe r formance evaluation is a central feature of an effective management information system. A
management information system is a comprehensive system to provide all levels of management
in a firm with information so that production, marketing, and financial functions can be effec-
tively performed to achieve the objectives of the firm. Management must plan its economic activ-
ities in advance, carry out its plans, and make sure that deviations are properly evaluated and
handled. Thus, performance evaluation based on the concept of the management information
system relates to the fundamentals of the management process: planning, execution, and control.
Because every subsidiary is unique in many respects, each subsidiary should be evaluated on
the basis of specific targets and individual objectives set for each. A survey of 125 MNCs by
Person and Lessig (1979) identified four purposes of an internal evaluation system: (1) to ensure
adequate profitability; (2) to have an early warning system if something goes wrong; (3) to have
a basis for the allocation of resources; and (4) to evaluate individual managers. The study also
re vealed that MNCs always use more than one criterion to evaluate the results of their foreign
subsidiaries. Of course, the performance evaluation system is designed to measure actual perfor-
mance against budgeted objectives as well as the prior year’s results. In the best of situations, the
evaluation system should monitor and control performance on a year-to-date and regular basis.
PERFORMANCE CRITERIA MNCs use multiple performance evaluation criteria because no
single criterion can capture all facets of performance that interest management at the main head-
quarters. Moreover, no single basis of measurement is equally appropriate for all units of an
MNC. For example, companies can appropriately evaluate their production unit on the basis of
such measures as cost reduction, quality control, and meeting shipment targets. For a sales unit,
however, cost reduction and quality control may be less appropriate than such measures as market
share and number of new customers. Thus, it is highly desirable for companies to use multiple
bases for performance measurement; that is, different ones for different kinds of operations in
different countries.
Two broad groups of performance evaluation criteria – financial criteria and nonfinancial
criteria – are used most widely by companies for evaluating their overseas operations. The  return
on investment relates enterprise income to some specified investment base such as total assets.
Many companies compare their actual operating performance with their budgeted performance;
budgets are pre-established standards against which operations are evaluated, compared, and
adjusted by the exercise of control. Abdallah and Keller (1985) surveyed 64 MNCs to identify
the financial criteria that they used to evaluate the performance of foreign subsidiaries. Accord-
ing to Abdallah and Keller, the four most important criteria were: (1) return on investment (ROI),
(2) profits, (3) budgeted ROI compared to actual ROI, and (4) budgeted profit compared to
actual profit.
Many MNCs do not confine their performance criteria to mere financial considerations. Non-
financial criteria complement financial measures because they account for actions that may not
contribute directly to profits in the short run but may contribute significantly to profits in the
long run. The market share is measured by sales or orders received as a percentage of total sales
in a market. The sales growth is measured by unit volume gains, selling price increases, and
exchange variations. Other important nonfinancial criteria include quality control, productivity
improvement, the relationship with the host-country government, cooperation with the parent
company, employment development, employee safety, and community service.
Once questions of performance criteria have been resolved, companies should ascertain
whether their criteria could be useful in comparing a foreign unit’s performance against its com-
petitors’ performance, either in the same country or across different borders. However, there are
many pitfalls in such comparisons. For example, it is almost impossible to determine the trans-
fer pricing of competitors as well as their accounting principles. Certainly, cross-border compar-
isons would compound the problem even further. Companies with many affiliates – at home or
abroad – must also take caution whenever questions of comparability arise. Differences in sub-
sidiaries would automatically distort performance comparisons unless they are directly accounted
for. Even if subsidiary objectives are the same, differences in country risk profiles, such as exchange
controls and export subsidies, could distort performance comparisons.
PERFORMANCE MEASUREMENT ISSUES There are many crucial, yet perplexing, elements in the
performance evaluation process. As described earlier, two measurement problems unique to
MNCs are exchange rates and inflation.
Perhaps the most critical element in the evaluation process is how to deal with results that are
denominated in currencies other than that of the parent company. The financial performance of
ov erseas operations can be measured in terms of local currency, home-country currency, or both. If
major changes occur in the exchange rates, the choice of currency can have a significant effect on
the assessment of a foreign subsidiary’s performance. For example, a subsidiary could make a profit
in local currency but could incur a loss in the parent company’s currency. Most US companies
analyze the operating results of their foreign operations in dollar terms. However, several of these
companies also use different rates for budgeting and performance tracking, because they recognize
variations between actual and expected results, which arise purely from exchange rate changes.
Fluctuating exchange rates may pose the most significant obstacle to proper evaluation, but
this is certainly not the only environmental factor. Wide variations and rapid changes in infla-
tion rates from country to country also complicate the evaluation process. Generally, accepted
accounting principles in the United States are based on the assumption of price stability. However,
other countries have runaway inflation, thus making it essential to adjust local asset values for
changing prices. Such restatements directly affect the measurement of various ROI components
and performance statistics for budgeting purposes. Because failure to account for inflation may
result in an overstatement of return on investment, company resources may not be channeled to
their most promising use. Unfortunately, solutions to these problems are not readily formulated.
Fur thermore, MNCs must consider two sets of laws, two competitive markets, and two govern-
ments. As a result, pricing considerations in international business are more numerous, more
complex, and more risky than those in purely domestic business.
 Organizational structure
As strictly domestic companies evolve into MNCs, many internal and external pressures strain a
firm’s existing organizational structure. Some responsibilities are changed, new ones are created,
and some existing ones are eliminated. Furthermore, control and finance functions change over
time as changes occur in countries’ socioeconomic environments. Companies must constantly
adjust their organizational structure to deal with new opportunities and challenges as they grow,
diversify, and internationalize.
How should the financial staff of a company with foreign operations organize itself to carry
out tasks that require the specialized expertise of multinational finance? There are three basic
forms of organizational structure: centralization, decentralization, and hybrid structure.
A centralized financial function has a strong staff at the parent company level, which controls
virtually all treasury decisions. The subsidiary financial staff only implements the decisions of
its parent company. In a decentralized financial function, parent-company executives issue a few
guidelines, but most financial decisions are made at the subsidiary level. Many companies split
responsibilities for international financial management between the corporate level and the
regional level. The corporate level typically determines policy and grants ultimate approval on
major financial decisions. However, day-to-day decisions to implement policy are made at
regional headquarters.
Both centralization and decentralization carry advantages. The advantages of a centralized
financial function include close control of financial issues at headquarters, attention of top man-agement to key issues, and an emphasis on parent-company goals. A decentralized company may
argue that these advantages could be disadvantages. Data collection costs may be enormous,
centralized decision-making may stifle flexibility, and many opportunities may be lost because of
slow actions.
DECISION VARIABLES The ultimate choice of a particular organizational structure depends
largely upon the types of decisions one must make: (1) transfer pricing and performance evalu-
ation, (2) tax planning, (3) exchange exposure management, (4) acquisition of funds, and (5)
positioning of funds.
First, transfer pricing decisions made to minimize taxes may ruin the performance evaluation
system for foreign subsidiaries. This problem sometimes forces a company to keep a second set
of books for evaluation purposes. Many MNCs may, in fact, keep three or more sets of books:
one for taxes, one for financial reporting, and one for evaluation purposes. There may be a need
for two transfer prices: one for tax purposes made at headquarters and one for evaluation pur-
poses decided by direct negotiations between affiliates.
Second, the centralized organization usually works well to minimize worldwide taxes. When
tax planning is centralized, it is easier to use tax-haven countries, tax-saving holding companies,
and transfer pricing. Thus, it is more efficient for MNCs to centralize their tax planning func-
tion rather than allow each region to create its own layer of tax havens and holding companies.
Third, most companies centralize their foreign-exchange exposure management, because it is
difficult for regional or country managers to know how their foreign-exchange exposure relates
to other affiliates.
Fourth, many MNCs borrow money from local sources for their working capital. On the
other hand, cheap sources of funds depend upon alternatives in all capital markets and the cost
of exchange gains or losses. Regional managers can hardly know all alternative sources of funds
outside a local market.
Fifth, positioning funds involves paying dividends and making intracompany loans, thereby
reducing consideration of total corporate tax liabilities, foreign-exchange exposure, and the avail-
ability of capital. Consequently, most companies tend to control positioning of funds from a cen-
tralized vantage point rather than from a regional viewpoint.