404 Planning and Forecasting
of their responsibilities. At least in the case of transactional exposure, Black &
Decker managers have in the past had this as part of their duties. However,
this would still leave open the effect of translation exposure on results and per-
formance evaluation. As Black & Decker reports:
Foreign currency transaction and commitment exposures generally are the re-
sponsibility of the Corporation’s indiv idual operating units to manage as an
integral part of their business. Management responds to foreign exchange move-
ments through many alternative means, such as pricing actions, changes in cost
structure, and changes in hedging strategies.^50The goal of the above discussion is to highlight how the evaluation of for-
eign subsidiaries and their management represents a special challenge because
of the ways in which exchange rate movements can affect measures of finan-
cial performance. Another factor that also affects such performance evaluation
is the issue of transfer pricing. These are the prices charged when goods are
transferred between related foreign and domestic firms. The issue oftransfer
pricingis discussed next.
Transfer Pricing and the Multinational Firm
The prices at which goods or services are transferred between related entities,
such as parents and subsidiaries and divisions of the same firm, are referred to
as transfer prices. Transfer prices could be a major factor in determining the
profits of the Fashionhouse Danish subsidiary because much of its product is
shipped to its U.S. parent. As in the previous case, the discussion here will focus
on the dimensions of transfer pricing that are inf luenced by the foreign status of
the subsidiary. The general topic of transfer pricing has been hotly debated over
many years. The setting of transfer prices, to both encourage optimal decision-
making and to facilitate performance evaluation, is not yet a settled matter.
Transfer prices are generally based upon cost, cost plus some markup, or
some approximation of market. Firms with international operations typically
disclose their method of pricing transfers of goods and services among differ-
ent taxing jurisdictions—typically countries. Some recent examples of transfer
pricing policies are presented in Exhibit 12.30.
The levels at which transfer prices are set is inf luenced by a wide range of
sometimes conf licting objectives. These include maximizing worldwide profits
af ter taxes,maintaining f lexibility in the repatriation of profits, encouraging
optimal decision making by profit center management, providing profit data
that are reliable indicators of managerial performance and entity profitability,
building market share, and maintaining competitiveness in foreign markets.^51
There is some variation in the transfer pricing policies used by U.S. firms,
with the key distinction being market value versus cost-based transfer prices.
Moreover, these policies can have a major impact on measures of financial per-
formance of the foreign subsidiary. They become another factor, in addition to
changing exchange rates, that must be considered in evaluating financial per-
formance of a foreign subsidiary and its management.