Global Finance 401EVALUATING THE PERFORMANCE OF FOREIGN
SUBSIDIARIES AND THEIR MANAGEMENT
With the acquisition of its Danish subsidiary, Fashionhouse is faced with the
need to report and evaluate the performance of the subsidiary as an economic
entity, as well as the performance of the subsidiary’s management. The discus-
sion here will focus only on those differences that result from the foreign char-
acter of the subsidiary. Aside from this, performance evaluation should be
fundamentally the same as for a domestic firm. The fact that, after the transla-
tion process, financial statements are available in both the domestic currency
(krone in the case of Fashionhouse) and the U.S. dollar is an important differ-
ence. Should performance of the subsidiary and its management be judged on
the basis of the krone or dollars results? Moreover, the earnings performance
of the Fashionhouse subsidiary will be affected each year by (1) the movement
of the krone against the dollar and (2) prices set (a transfer price) on the goods
sold to Fashionhouse in the United States.
Impact of Exchange Rate Movements on
Performance Evaluation
A number of years ago, an issue arose concerning the incentive compensation
of the manager of a Netherlands subsidiary of a major U.S. heav y equipment
manufacturer. A strong profit performance was produced in the European cur-
rency, but the translated results were a loss (note: translation followed the tem-
poral and not the all current method). After lengthy consideration by senior
management, a decision was made that no incentive compensation was to be
awarded. Management held that failure of the Netherlands subsidiary to earn a
profit in dollars resulted in its making no contribution to the parent, whose
goal was to maximize the dollar earnings of the consolidated entity. The man-
ager of the Netherlands subsidiary was not pleased.
A central precept of performance evaluation is that managers should only
be held responsible for results that incorporate variables over which they exer-
cise some reasonable control. Depending upon the circumstances, this might
mean that in judging the performance of a department foreman, the quantity
of material used is considered controllable but not its price. For performance
evaluation purposes, the material used would be priced at some prearranged
standard and not its actual cost. On the other hand, the vice president of man-
ufacturing might well be held responsible for actual material cost on the basis
that he or she has been assigned responsibility for the price of material used,
as well as its quantity.
Applied to evaluating the performance of the management of foreign sub-
sidiary, the concept of a controllable performance indicator would call for
either (1) using the profit results from the foreign-currency statements or
(2) using the translated dollar earnings, after adjustments designed to remove