Global Finance 403The previous adjustment holds constant the value of the foreign currency
in measuring net income for purposes of performance evaluation. In judging
the subsidiary itself as an economic unit, translation at the depreciated value of
the foreign currency may still be appropriate. The dollar value of the net in-
come produced is indeed lower because of the currency depreciation in the
subsidiar y’s countr y.^49
An alternative approach that is sometimes used is to evaluate the perfor-
mance of management is to use budgeted foreign exchange rates. This is simi-
lar to the above in that it holds the exchange rate constant. However, the
constant rate is a budgeted exchange rate and not simply the rate from the pre-
vious year.
There is ample evidence in U.S. annual reports of adjustments to control
for the impact of foreign-exchange changes on performance. It is standard for
the Management’s Discussion and Analysis of Operations section, an SEC re-
quirement, to include commentary on the impact of exchange rate changes on
revenues, though far less frequently on earnings. However, Philip Morris does
identify the effect of exchange-rate changes on both revenues and the income
of operating companies. Three recent examples follow:
Johnson & Johnson Inc. (1999)
Sales by international companies were $12.09 billion in 1999, $11.15 billion in
1998 and $10.93 billion in 1997. This represents an increase of 8.4% in 1999,
1.9% in 1998 and 1.5% in 1997. Excluding the impact of foreign currency f luc-
tuations over the past three years, international company sales increased 12.4%
in 1999, 7.1% in 1998 and 9.6% in 1997.
Philip Morris Companies Inc. (1999)
Currency movements decreased operating revenues by $782 million ($517 mil-
lion, after excluding excise taxes) and operating companies income by $46 mil-
lion during 1999.
Praxair Inc. (1999)
The sales decrease of 4% in 1999 as compared to 1998 is due primarily to unfa-
vorable currency translation effects in South America. Excluding the impact of
currency, sales grew 2%.Changes in exchange rates present a clear challenge in evaluating the per-
formance of both the economic units, such as the foreign subsidiaries, as well as
the management of these organizations. The emphasis on foreign operations is
on results in the domestic and not the foreign currency. This can create obvious
problems in the evaluation of the management of foreign subsidiaries because
their results in the foreign currency may improve or decline while their perfor-
mance expressed in the domestic (parent’s) currency declines or improves.
If foreign entity managers have little control over their results in the par-
ent’s currency, then judging their performance in that currency presents clear
problems. Performance evaluation in the domestic versus the foreign currency
should require that unit management have currency risk management as part