Comparing the profitability of firms in Germany, Japan, and the United States.Introduction
In a world characterized char·ac·ter·ize
tr.v. character·ized, character·iz·ing, character·iz·es
1. To describe the qualities or peculiarities of: characterized the warden as ruthless.
2. by global markets and competition, significant differences in the profitability of similar firms domiciled dom·i·cile
1. A residence; a home.
2. One's legal residence.
v. dom·i·ciled, dom·i·cil·ing, dom·i·ciles
1. in different countries should not be present. The logic behind this argument is as follows: 1) The creation of global markets and industries causes similar firms in all nations to face identical environmental threats and opportunities. 2) Firms in similar environmental contexts tend to adopt similar organizational responses (i.e. strategies and structures). 3) Since performance is a function of the "fit" between a firm's structure and its environmental context, firms that adopt similar organizational responses should also tend to earn similar rates of return. 4) Therefore, similar firms headquartered in different nations should achieve similar levels of profitability. Support for each of these propositions appears below.
Hout, Porter, and Rudden (1982), Porter (1986), Prahalad and Doz (1987), Bartlett and Ghoshal (1989), Ohmae (1990), Reich (1990, 1991) and many others have noted that competition has become increasingly "global" in nature. According to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. Levitt (1983), technology and telecommunications Communicating information, including data, text, pictures, voice and video over long distance. See communications. are the driving forces of globalization globalization
Process by which the experience of everyday life, marked by the diffusion of commodities and ideas, is becoming standardized around the world. Factors that have contributed to globalization include increasingly sophisticated communications and transportation by promoted the convergence of consumer tastes and demands around the World. But whatever the reasons, firms no longer compete on the basis of "country-specific" advantages such as low wage rates, access to natural resources, or the unique characteristics of local markets. Instead, firms in a growing number of industries compete on the basis of well coordinated, global production and distribution systems which allow them to serve all of the World's major markets simultaneously.
In terms of the present study, global markets and competition mean that firms from all nations face largely identical competitive environments; and consequently, tend to adopt similar organizational responses (i.e. structures and strategies). Support for this notion comes from studies by Vernon Vernon, city, Canada
Vernon, city (1991 pop. 23,514), S British Columbia, Canada, near the north end of Okanagan Lake. The center of a fruit-growing and dairying area, it has packing and dehydrating plants. (1979), Robinson (1981), Dymsza (1984), Dunning Dunning
The process of communicating with customers to ensure the collection of accounts receivable.
Dunning can start with gentle reminders and then progress to nearly threatening letters as accounts become more past due. (1988), and others which suggest that Multinational Enterprises (MNEs) have virtually identical organizational properties regardless of their home countries. This occurs because the forces which encourage firms to become MNEs (such as gaining monopolistic advantages, reducing various transaction costs Transaction Costs
Costs incurred when buying or selling securities. These include brokers' commissions and spreads (the difference between the price the dealer paid for a security and the price they can sell it). , and protecting proprietary knowledge) affect firms from all nations in basically the same way. More importantly, however, contingency theory Contingency theory refers to any of a number of management theories. Several contingency approaches were developed concurrently in the late 1960s.
They suggested that previous theories such as Weber's bureaucracy and Taylor's scientific management had failed because they (Lawrence Lawrence.
1 City (1990 pop. 26,763), Marion co., central Ind., a residential suburb of Indianapolis, on the West Fork of the White River. It has light manufacturing.
2 City (1990 pop. 65,608), seat of Douglas co., NE Kans. and Lorsch Lorsch is a small town in southwest Germany (60 kilometers south of Frankfurt) in the Kreis Bergstraße district of Hesse. More than 12,000 people live in the town.
It is the site of the Benedictine Lorsch Abbey, which used to be one of the greatest centers of Carolingian art. 1967) implies that over time these forces will cause both the financial performance and organizational structures This article has no lead section.
To comply with Wikipedia's lead section guidelines, one should be written. of similar firms in different countries to converge con·verge
v. con·verged, con·verg·ing, con·verg·es
a. To tend toward or approach an intersecting point: lines that converge.
In general, contingency theories argue that a firm's performance is a function of the "fit" between its organizational structure and the environment in which it operates. Ghoshal and Nohria (1993) found strong support for this principle in a recent study of 41 North American North American
named after North America.
North American blastomycosis
see North American blastomycosis.
North American cattle tick
see boophilusannulatus. and European European
emanating from or pertaining to Europe.
European bat lyssavirus
European beech tree
see cryptococcosis. MNEs. In all cases, firms that exhibited the appropriate "environment-structure fit" outperformed others by a statistically significant margin. Since all firms in globally competitive industries face identical environmental threats and opportunities, and tend to adopt similar organizational responses as a result; they should also tend to earn roughly equivalent rates of return. Support for this latter contention comes from the fact that, in a global marketplace, firms must compete for the same international investments and finance them through the same pool of international capital regardless of their country of origin. In such an environment, differences in performance due to nationality nationality, in political theory, the quality of belonging to a nation, in the sense of a group united by various strong ties. Among the usual ties are membership in the same general community, common customs, culture, tradition, history, and language. are unsustainable for the simple reason that, firms or industries in one country which consistently earn above average, risk-adjusted returns Risk-Adjusted Return
A measure of how much risk a fund or portfolio takes on to earn its returns, usually expressed as a number or a rating.
This is often represented by the Sharpe Ratio. The more return per unit of risk, the better. will attract competitors and imitators from other nations until the returns generated by similar activities are equalized between countries.
But while the preceding arguments are compelling, they are predicated upon the assumption that most firms and industries are global in nature. This is certainly true for a large number of firms and industries (particularly the ones examined in this study); however, it is clearly not true for all of them. Consequently, differences in profitability may persist for firms in industries characterized by "multi-domestic" (rather than global) competition, and/or and/or
Used to indicate that either or both of the items connected by it are involved.
Usage Note: And/or is widely used in legal and business writing. those which operate only in their domestic markets. In addition, the argument assumes a "perfectly competitive" global economy in which firms and investors can move resources across national boundaries without restrictions. Given the ability of governments to dictate TO DICTATE. To pronounce word for word what is destined to be at the same time written by another. Merlin Rep. mot Suggestion, p. 5 00; Toull. Dr. Civ. Fr. liv. 3, t. 2, c. 5, n. 410. the competitive environment in many industries (see Yoffie 1993) this assumption may be somewhat optimistic op·ti·mist
1. One who usually expects a favorable outcome.
2. A believer in philosophical optimism.
op ; nonetheless, it provides a useful conceptual basis for the present investigation.
However, one problem does warrants further discussion; namely, the effects of national differences in business practices and accounting standards on the indicators used to measure firm performance. Since these indicators are generally affected by the rate of corporate taxation, the method used to account for various income statement and balance sheet items, the firm's level of debt or equity, and a host of other factors, apparent national differences in profitability may reflect more fundamental differences in the legal structure, business practices, and accounting standards of the countries involved. Thus, before proceeding with the current study, it is imperative that major differences in accounting and business practices between Germany Germany (jûr`mənē), Ger. Deutschland, officially Federal Republic of Germany, republic (2005 est. pop. 82,431,000), 137,699 sq mi (356,733 sq km). , Japan, and the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. be identified and their effect on reported profitability be evaluated. This is the purpose of the following two sections.
In his book, Financial Statement Analysis, Foster (1978) identifies three widely used measures of firm profitability. They are: 1) Return on Assets Return on assets (ROA)
Indicator of profitability. Determined by dividing net income for the past 12 months by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net income/sales) multiplied by asset utilization (sales/assets). (ROA ROA
See: Return on assets
See: Right of accumulation
See return on assets (ROA). ), 2) Return on Equity (ROE A fictitious surname used for an unknown or anonymous person or for a hypothetical person in an illustration.
A lawsuit is generally named for the persons who are parties to it. ), and 3) Expenses to Revenue (i.e. Operating Margin Operating Margin
A ratio used to measure a company's pricing strategy and operating efficiency.
Calculated by: ).
Return on assets is simply the ratio of net income after taxes to total assets, and provides an indication of how efficiently a firm employs its assets. In most case, net income is adjusted by adding back the firm's interest expense minus the tax savings of that expense in order to facilitate the comparison of firms which use various levels of debt and equity to finance their activities. This adjustment is necessary because dividend payments to equity holders are usually made after taxes, while interest payments on debt are made before taxes. Return on equity is calculated by dividing net income available to common (i.e. after taxes and preferred dividend preferred dividend n. a payment of a corporation's profits to holders of preferred shares of stock. (See: preferred stock) payments) by common shareholder's equity, and measures the return generated on the firm's shareholder equity. Finally, the operating margin is the ratio of operating income Operating Income
The profit realized from a business' own operations.
This would not include income from things such as investments in other firms. Also referred to as operating profit or recurring profit. (i.e. sales minus operating expenses Operating expenses
The amount paid for asset maintenance or the cost of doing business, excluding depreciation. Earnings are distributed after operating expenses are deducted. ) to sales, and provides a measure of the profitability of a firm's basic operations. Unlike ROA and ROE which use net (after tax) profit as a guide, the operating margin is based on income before the effects of taxes, interest earnings and expenses, or extraordinary gains and losses have been assessed. As a result, this indicator often provides a more meaningful measure of a firm's underlying strength than either ROA or ROE.
Each of these ratios can provide valuable information about the performance of a particular firm or industry; however, all three indicators are affected by the legal framework and accounting standards used to generate the firm's income statement and balance sheet. Cohen cohen
(Hebrew: “priest”) Jewish priest descended from Zadok (a descendant of Aaron), priest at the First Temple of Jerusalem. The biblical priesthood was hereditary and male. , Zinbarg, and Zeikel (1982), and Love (1992) provide instructive in·struc·tive
Conveying knowledge or information; enlightening.
in·structive·ly adv. discussions of the effects of accounting practices on a wide range of financial ratios. Among the most important factors-other than performance-affecting the measured profitability of the firm are: 1) the tax rate and the presence or absence of specific tax and investment credits; 2) the accepted method of accounting for various income statement and balance sheet items, particularly, depreciation, R&D spending, minority investments, leases, goodwill, and currency translations; and 3) the effect of using debt versus equity to finance the firm's activities.
Indicators that use net income to assess profitability (i.e. ROA and ROE) are affected by all three factors, since they have a direct effect on the firm's reported income, assets, or equity. As noted above, return on assets attempts to correct for differences in the firm's financial structure (i.e. its preference for debt or equity) by adjusting net income for the interest expense and its tax effect; but ROA is plagued by additional difficulties relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc the definition and valuation of assets. Many of these complications can be avoided by using the operating margin. Since this indicator is based on operating rather than net income, it is not affected by taxes, interest and dividend payments, or extraordinary gains and losses. Further, the use of sales -- rather than assets or equity -- as a guide, sidesteps many definitional problems. Unfortunately, many companies earn a large portion of their income from activities which have little to do with their basic operations, and therefore, are not reflected in the firm's operating margin.
Thus, the three most widely used profitability indicators are subject to certain limitations which makes it extremely difficult to accurately assess firm performance. Further, as Al Hashim and Arpan (1988), Choi Choi may refer to:
Accounting Practices in Germany, Japan, and the U.S.
Table 1 presents an overview of accounting standards in Germany, Japan, and the United States based on a recent study by the Center for International Financial Analysis and Research (CIFAR CIFAR Cooperative Institute for Arctic Research
CIFAR California Institute of Food and Agricultural Research
CIFAR Canadian Institute for Advanced Research 1991). This source provides basic information about the practices in place during the late 1980s and has been complemented by additional references in the discussion that follows. In general, the table assembles the most widely used practices in each country; however, it is important to recognize that frequent changes in accounting regulations and the extreme complexity and diversity of accounting practices -- both between and within countries -- makes it impossible to provide more than a general summary of these standards. Perhaps the most important differences to emerge from the CIFAR study are: 1) differences in the methods used to account for depreciation in each country, 2) differences in the requirements for and methods of consolidating a firm's foreign and domestic operations, 3) differences in the methods used to account for foreign currency gains and losses, and 4) the widespread use of general and special reserve funds in Germany and Japan. The potential effects of these differences on the reported profitability of firms in each nation are discussed below.
By affecting both income and the value of assets, the method used to account for depreciation will affect all three profitability indicators. Currently, Japanese Japanese (jăp'ənēz`), language of uncertain origin that is spoken by more than 125 million people, most of whom live in Japan. There are also many speakers of Japanese in the Ryukyu Islands, Korea, Taiwan, parts of the United States, and firms use accelerated depreciation Accelerated Depreciation
Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years of the life of an asset.
The straight-line depreciation method spreads the cost evenly over the life of an asset. , while most American American, river, 30 mi (48 km) long, rising in N central Calif. in the Sierra Nevada and flowing SW into the Sacramento River at Sacramento. The discovery of gold at Sutter's Mill (see Sutter, John Augustus) along the river in 1848 led to the California gold rush of companies use the straight line method. In Germany, firms use either straight line or accelerated TABULAR tab·u·lar
1. Having a plane surface; flat.
2. Organized as a table or list.
3. Calculated by means of a table.
resembling a table. DATA OMITTED depreciation depending on the type of asset and may also take excess depreciation under certain circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or . Accelerated depreciation allows a firm to deduct de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. the cost of a capital investment over a shorter period of time, and therefore, firms using this method will report both lower incomes and assets in the short run than identical firms that use straight line depreciation (although both methods produce the same results over the life of an asset). Since capital investment in Germany and Japan has been relatively high in recent years, the Years, The
the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109]
See : Time use of accelerated and/or excess depreciation in these countries will have a negative impact on the reported incomes (both operating and net) of firms in both nations. Consequently, Japanese and German firms should report moderately lower operating margins and ROEs than identical American companies. The effect of accelerated and excess depreciation on ROAs is somewhat more difficult to determine because these practices decrease both the numerator numerator
the upper part of a fraction.
see additive genetic relationship.
numerator Epidemiology The upper part of a fraction (i.e. net income) and denominator denominator
the bottom line of a fraction; the base population on which population rates such as birth and death rates are calculated.
denominator (i.e. assets) of this indicator. However, since a firm's income is typically less than its assets, higher rates of depreciation should have a proportionally pro·por·tion·al
1. Forming a relationship with other parts or quantities; being in proportion.
2. Properly related in size, degree, or other measurable characteristics; corresponding: greater effect on income, reducing the firm's ROA accordingly. Thus, ceteris paribus Ceteris Paribus
Latin phrase that translates approximately to "holding other things constant" and is usually rendered in English as "all other things being equal". In economics and finance, the term is used as a shorthand for indicating the effect of one economic variable on , Japanese and German companies will tend to report lower operating margins, ROE, and ROAs than identical American companies.
The second major difference in accounting practices involves the requirements for and methods of preparing consolidated financial statements Consolidated Financial Statements
The combined financial statements of a parent company and its subsidiaries.
Because consolidated financial statements present an aggregated look at the financial position of a parent and its subsidiaries, they enable you to gauge in each nation. Consolidated statements provide information about the full range of a firm's activities by combining the financial statements of a parent company with those of its foreign and domestic subsidiaries. But while the benefits of consolidation are widely recognized, there is no universally accepted set of principles to guide the consolidation process. As a result, the quality and value of consolidated statements differs markedly between countries.
In the United States, consolidation of domestic majority-owned subsidiaries majority-owned subsidiary
A firm in which more than 50% of outstanding voting stock is owned by the parent company. has been required since the late 1950s, and foreign subsidiaries since 1971. Holzer Holzer is the surname of:
European Community (EC)
Organization formed in 1967 with the merger of the European Economic Community, European Coal and Steel Community, and European Atomic Energy Community. . Nonetheless, Choi and Mueller (1992) warn that many German and Japanese companies This is a list of companies from Japan. Note that 株式会社 can be (and frequently is) read both kabushiki kaisha and kabushiki gaisha (with or without a hyphen). See that article for more details. still do not fully consolidate their activities, although most large companies in both nations prepare fully consolidated statements based on U.S. practices for use by the international investment community. Clearly, to the extent that consolidation excludes significant foreign and domestic subsidiaries a firm's revenue, assets, and liabilities will be understated accordingly. Further, since a parent company is more likely to avoid the consolidation of poorly performing subsidiaries when possible, more flexible consolidation requirements in Germany and Japan may tend to improve the reported earnings -- and hence all three profitability indicators -- of firms in these countries, although this conclusion is by no means certain.
Not only are there differences between countries in the requirements to consolidate specific foreign or domestic subsidiaries, there are also differences in the methods used to consolidate those operations. Until the late 1980s, many German firms used the cost method to account for minority affiliates (i.e. those of 20-50% ownership), while American firms have been required to use the equity method since the early 1970s. The method used in Japan is somewhat complicated and depends on the number of majority-owned subsidiaries a firm possesses. According to Choi and Mueller, firms which have at least one majority-owned subsidiary must use the equity method for all their minority holdings, while firms with no majority-owned subsidiaries may use either the cost or equity method.
The cost method allows a firm to report its share of earnings from a minority investment only when it receives a dividend. On the other hand, the equity method requires a firm to report these earnings as an increase in assets whether a dividend is received or not. This distinction has two important implications. First, since a parent company is often able to influence its subsidiaries' dividend policy, firms that use the cost method may be able to control large fluctuations in their reported earnings to some extent by receiving a dividend in a particular accounting period. Consequently, (at least during the 1980s) the ROAs and ROEs of German firms may appear somewhat more stable than the returns of firms in the other two countries. Secondly, firms that use the cost method should, ceteris paribus, tend to report relatively higher incomes (both operating and net), and firms that use the equity method will tend to report relatively larger assets. Accordingly, German firms may display slightly higher ROEs and operating margins, while American (and many Japanese) firms should exhibit lower ROAs, than identical firms in the other nations.
The third difference cited above involves the methods used to account for foreign currency gains and losses. In general, these items occur for two reasons: 1) changes in exchange rates between the time a foreign currency payable or receivable is recorded and its settlement data (i.e. "transaction" gains or losses), and 2) the effect of exchange rates on the home currency value of foreign assets and liabilities subject to consolidation (i.e. "translation" gains or losses). This distinction is crucial because the former case results in a "realized" gain or loss, while the latter produces an "unrealized" or "paper" gain or loss. Not surprisingly, the methods used to account for each of these effects often differ.
In the U.S., FASB FASB
See: Financial Accounting Standards Board
See Financial Accounting Standards Board (FASB). 52 (Financial Accounting Standards Board Financial Accounting Standards Board (FASB)
Board composed of independent members who create and interpret Generally Accepted Accounting Principles (GAAP). ) requires finns to recognize transaction gains and losses as an adjustment to current income with certain minor exception, and to take translation gains and losses through a special account in the balance sheet. In other nations, the methods used to account for these items are quite varied. For example, in Germany, there is no official regulation regarding foreign currency gains and losses although it is recommended that firms disclose the method they use and that it have no effect on the firm's earnings. As a result, many German firms take these adjustments through the balance sheet. Similarly, most Japanese firms take currency gains and losses through the balance sheet, although many larger firms follow the U.S. practice and adjust current income in some cases. Clearly, to the extent that Japanese and German companies can avoid making adjustments to income, their earnings -- and hence ROAs and ROEs -- may appear more stable than American firms. Further, these benefits increase as the firm's foreign activities increase and/or as exchange rates become more volatile.
There is an additional problems involved in the translation of foreign assets and liabilities during consolidation; namely, what exchange rate to use to value specific accounts. For our purpose the two most important methods are the "current rate" and "temporal Having to do with time. Contrast with "spatial," which deals with space. rate" methods. In very simplified form, the first approach uses the "current" exchange rate (i.e. the exchange rate in effect on the last day of the accounting period) to translate all of the firm's foreign assets and liabilities with the exception of common stock and paid in capital which uses the rate in effect at date of issue. On the other hand, the temporal rate method employs the "current" exchange rate to translate cash, receivable, payables Payables
Related: Accounts payable , certain current assets Current Assets
Appearing on a company's balance sheet, it represents cash, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that can be converted to cash within one year. , and long-term debt Long-Term Debt
Loans and financial obligations lasting over one year.
For example debts obligations such as bonds and notes which have maturities greater than one year would be considered long-term debt. ; while the "historic" exchange rate (i.e. the one in place when assets were acquired) is used to translate various assets valued at historical costs, such as plant and equipment and the cost of inventory and investments.
In the U.S., FASB 52 develops the concept of a "functional currency" (i.e. the primary currency in which a foreign entity operates) to prescribe pre·scribe
To give directions, either orally or in writing, for the preparation and administration of a remedy to be used in the treatment of a disease. how a company must translate its foreign assets and liabilities. According to Al Hashim and Arpan, in most cases this results in the use of the current rate method, although under certain conditions (specifically, when a foreign entity's functional currency is the U.S. dollar) the temporal method Temporal method
A currency translation method under which the choice of exchange rate depends on the underlying method of valuation. Assets and liabilities valued at historical cost (market cost) are translated at the historical (current market) rate. is used instead. The practices used in Germany and Japan are even less well defined, although Choi and Mueller note that many German companies use a modified current rate method (with many firms using historic rates to translate fixed assets fixed assets npl → activo sg fijo
fixed assets npl → immobilisations fpl
fixed assets fix npl → ), while most Japanese companies use a modified version of the temporal method (translating long-term Long-term
Three or more years. In the context of accounting, more than 1 year.
1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. monetary assets and liabilities Monetary assets and liabilities
Assets and liabilities with contractual payoffs. at their historic rates). Although this difference is subtle, by affecting the value of a firm's foreign assets, it can also impact the firm's ROA. This is particularly true given the dramatic appreciation of the mark and yen against the dollar in recent years. As a result of these currency moves, the temporal rate method could substantially overstate the value of many older, Japanese (and to some extent German) foreign assets relative to their current translated values. Similarly, the dramatic drop in the value of the dollar should increase the current dollar value of many older, U.S. foreign assets. Thus, while this difference does affects the asset base of firms in each nation, in most cases, its impact should be to increase the value of older foreign assets and thereby reduce the ROAs of firms in all three countries.
The final major difference in accounting practices between countries involves the widespread use of general and special reserve funds in Germany and Japan. Both nations require firms to establish legal reserves equal to at least 10% in Germany and 25% in Japan of the value of the firm's capital stock, although firms often retain far greater amounts in these accounts. In addition, both countries allow firms to create general and/or special purpose reserve funds for a wide range of activities. In Japan, for example, general reserves may be used for R&D development, dividend equalization In communications, techniques used to reduce distortion and compensate for signal loss (attenuation) over long distances. , director's retirement benefits, or overseas market development, while reserves in Germany are typically the result of legislation designed to affect economic and/or social objectives.
In terms of the present discussion, reserve funds have two important effects. First, since within certain limits additions to reserves are taken from pretax income pretax income
Reported income before the deduction of income taxes. Pretax income is sometimes considered a better measure of a firm's performance than aftertax income because taxes in one period may be influenced by activities in earlier periods. , contributions will reduce the firm's pretax income and earnings. As a result, the returns on assets and returns on equities of German and Japanese companies may be moderately lower than those of similar American firms. Second, although not strictly legal, firms in both countries can use these funds to reduce fluctuations in their income and earning streams by building up reserves in good years for use in bad ones. Holzer, and Ballon bal·lon
Buoyancy or lightness in movement that allows a dancer to rise and fall smoothly.
[French, balloon; see balloon.] and Tomita (1988) cite studies of German and Japanese firms respectively which indicate that such practices have declined substantially since the early-mid 1970s; nonetheless, it seems reasonable to suggest that all three profitability indicators may exhibit somewhat less variability for German and Japanese than for American companies.
In addition to these accounting practices, two other issues deserve special mention; namely, differences in corporate tax rates in the U.S., Germany, and Japan; and the effect of using debt versus equity to finance the firm's activities. During the 1980s, tax rates differed dramatically between these countries. Based on data contained in Disclosure/Worldscope's (1991), "Industrial Company Profiles", between 1984 and 1989 the average effective tax rate dropped from about 70% to roughly 45% in Germany; from 60% to 55% in Japan; and from about 45% to roughly 37% in the U.S. As a result of these differences, any direct comparison of ROAs and ROEs between countries will be highly biased since, ceteris paribus, American companies will report higher after tax (i.e. net) incomes, and hence higher ROAs and ROEs, than equivalent Japanese and German companies.
Finally, since interest payments on debt are subtracted before -- but dividend payments on equity are made after -- net income has been calculated, firms which use higher levels of debt to finance their activities will report lower net incomes than identical firms which use equity. Although this difference does not affect comparisons of returns on assets or operating margins, it may bias the direct comparison of returns on equity. Data contained in the "Industrial Company Profiles" suggests that debt to equity ratios The debt to equity ratio (D/E) is a financial ratio indicating the relative proportion of equity and debt used to finance a company's assets. It is equal to total debt divided by shareholders' equity. varied widely between Germany, Japan, and the U.S. during the 1980s. German firms used the least amount of debt, with average debt to equity ratios remaining relatively stable at 24-26% over the 1984-89 period. On the other hand, the debt levels of American corporations increased substantially, equaling -- and in some cases surpassing -- the much higher debt levels of Japanese companies. Specifically, the average debt to equity ratio of U.S. firms increased from 39% to roughly 66% between 1984 and 1989; while the ratio for Japanese firms remained stable at 50-55% over the period.
The ultimate impact of these differences depends on whether interest payments made by Japanese and U.S. companies reduce their net incomes (and thus ROEs) more than the increased use of equity by German firms lowers their ROEs. It seems reasonable to argue that firms borrow money with an expectation of earning more than they pay in interest; and therefore, ceteris paribus, the effect of debt will be to increase net income. Accordingly, Japanese and American firms should generate higher ROEs than their German counterparts.
Table 2 summarizes all of the effects discussed thus far. Unfortunately, it is extremely difficult to draw definite conclusions about the combined effect of these differences in accounting practices on the observed profitability of firms in Germany, Japan, and the United States, particularly since their effects often work in opposite directions. Studies conducted in the late 1970s found that accounting practices in Germany and Japan often reduced the reported earnings of firms in these countries by as much as 50% relative to contemporary American standards (See Choi 1982, Holzer 1984, Choi and Mueller 1984, 1992); although there are many reasons to believe that the increased globalization of financial markets has considerably reduced the magnitude of these effects. A more recent study by Schieneman (1988) adjusted the financial statements of a small group of foreign firms in the Telecommunications industry to reflect Generally Accepted Accounting Practices in the United States. Schieneman concluded that restatement Restatement
A revision in a company's earlier financial statements.
The need for restating financial figures can result from fraud, misrepresentation, or a simple clerical error. did indeed affect the net incomes and equities of many of these firms, but the magnitude and direction of these changes were not consistent -- even for firms in the same country.
TABULAR DATA OMITTED
Nevertheless, based on the preceding analysis, several tentative tentative,
adj not final or definite, such as an experimental or clinical finding that has not been validated. conclusions can be advanced. First, all three profitability indicators may exhibit somewhat less volatility for German and Japanese companies firms due to their ability to "smooth" reported income to some extent, particularly through the use of various types of reserve funds. Second, the methods used to account for depreciation and the ability to built reserves from pretax income in Japan and German may cause firms in these nations to report moderately lower incomes (both operating and net) than their American counterparts. As a result, Japanese and German companies should have relatively lower operating margins, ROAs, and ROEs, than American companies. This tendency is reinforced by the lower effective tax rate in the U.S. which favors American firms in any direct comparison of nominal ROAs or ROEs. Finally, it is important to remember that these outcomes are an artifact A distortion in an image or sound caused by a limitation or malfunction in the hardware or software. Artifacts may or may not be easily detectable. Under intense inspection, one might find artifacts all the time, but a few pixels out of balance or a few milliseconds of abnormal sound of the specific accounting and business practices used in each nation, and do not reflect real differences in firm performance.
Review of Previous Research
Before proceeding with a description of the empirical study, it may be useful to briefly review previous research into the performance of firms in different countries. Due to the abundance Abundance
See also Fertility.
horn horn of Zeus’s nurse-goat which became a cornucopia. [Gk. Myth.: Walsh Classical, 19]
conical receptacle which symbolizes abundance. [Rom. Myth. of these studies, only a few examples are presented below; however, they should suffice suf·fice
v. suf·ficed, suf·fic·ing, suf·fic·es
1. To meet present needs or requirements; be sufficient: These rations will suffice until next week. in illustrating the wide range of both methodologies and outcomes associated with this research. For example, a study of manufacturing companies in the U.S. and Japan by Choi (1982) found substantial differences in the average returns on sales (ROS ROS,
n.pr See reactive oxygen species. ), returns on assets, and returns on net worth of firms in each country. In all cases, Japanese firms generated substantially lower returns than their American counterparts. Further, when these ratios were adjusted to reflect a common set of accounting rules, Choi concluded that restatement explained only a minor portion of the observed differences.
Soenen and Van den Bulke (1988) employed a novel approach to correct for differences in accounting practices in their study of large Belgian companies This is a list of companies of Belgium. For a list of companies from across the EU, see List of European companies. Current companies
having some relationship to Belgium.
Belgian barge dog
Belgian black pied cattle
black, Belgian dairy cattle.
dual-purpose cattle; blue, white or blue roan. firms had somewhat lower sales -- but larger assets -- than the American and European subsidiaries, and earned consistently lower returns over the 1979-83 period. American subsidiaries earned the highest returns with an average return on sales Return on sales
A measurement of operational efficiency equalingnet pre-tax profits divided by net sales expressed as a percentage.
return on sales
The portion of each dollar of sales that a firm is able to turn into income. of 5.4%, return on assets of 9.4%, and return on equity of 7.3%. European subsidiaries had an average ROS of 3.5%, ROA of 7.4%, and ROE of 5.7%; while Belgian firms had an ROS, ROA, and ROE of 3.1%, 4.8%, and 3.4% respectively.
In a study of the 100 largest American and European MNEs, Geringer, Beamish, and daCosta (1989) uncovered Uncovered may refer to:
A risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance.
Diversification is possibly the greatest way to reduce the risk. strategy and its performance.
Using regression analysis In statistics, a mathematical method of modeling the relationships among three or more variables. It is used to predict the value of one variable given the values of the others. For example, a model might estimate sales based on age and gender. , Haar (1989) studied the 50 largest American, European, and Japanese companies (based on 1985 sales) in order to test the significance of various factors in explaining firm performance (as measured by return on assets). Among the variables examined were firm size, degree of multinationality, past profitability, state ownership, nationality, and industrial environment. Previous studies by Buckley, Dunning, and Pearce (1978), and Rugman (1983) had established nationality as a significant determinant determinant, a polynomial expression that is inherent in the entries of a square matrix. The size n of the square matrix, as determined from the number of entries in any row or column, is called the order of the determinant. of firm performance; however, Haar found that over the 1980-85 period nationality was significant for Japanese MNEs, but had only a minimal effect for European firms. Unfortunately, it is not possible to discern dis·cern
v. dis·cerned, dis·cern·ing, dis·cerns
1. To perceive with the eyes or intellect; detect.
2. To recognize or comprehend mentally.
3. the explanatory ex·plan·a·to·ry
Serving or intended to explain: an explanatory paragraph.
ex·plan power of nationality from Haar's tables, although its unique effect is probably rather limited. Based on Haar's data, the average annual ROAs of European, Japanese, and American firms between 1980-85 were 1.5%, 2.4%, and 5.8% respectively. In addition, Haar noted that the average profitability of European and American firms had decreased markedly since the mid-late 1970s, while the performance of Japanese MNEs had increased.
Finally, a study by Lee and Blevins (1990) examined the performance of a group of large American, Japanese, South Korean, and Taiwanese companies between 1980-87 (most firms had annual sales of $ 0.5-2 billion and employed between 1000-5000 workers). Once again, American companies consistently outperformed their foreign rivals, achieving an average ROE of 12.98%, an ROA of 7.24%, and an ROS of 5.8% during the period. This compared to ROEs, ROAs, and ROSs of 6.56%, 2.22%, and 3.87% respectively for Japanese companies; 10.19%, 3.08% and 3.12% for Korean firms; and 7.22%, 3.28%, and 3.24% for Taiwanese companies. Although the authors made no attempt to adjust their data for differences in accounting practices, they clearly recognized the problems associated with this approach.
Due to the vast differences in the approaches utilized in these studies it is difficult to draw many strong conclusions from this brief survey of previous research. Nonetheless, it seems safe to say that American firms consistently outperformed similar Japanese and European firms during the late 1970s and 1980s.
Overview of the Empirical Study
As noted above, the primary objective of this paper is to examine the relative profitability of firms in Germany, Japan, and the United States. Toward this end, an empirical study of the average annual return on assets, return on equity, and operating margin of a large sample of American, German, and Japanese industrial companies was conducted (firms in the banking and financial services The examples and perspective in this article or section may not represent a worldwide view of the subject.
Please [ improve this article] or discuss the issue on the talk page. sectors were not included in this study). Specifically, 100 companies from each country were randomly selected from Disclosure/Worldscope's (D/W D/W
dock warrant ), "Industrial Company Profiles" (1991), and used to calculate annual national averages for each profitability indicator over the 1984-90 period. (Figures for 1990 were calculated from data contained in "Business Week's" Global 1000 (July 15, 1991) and represent a slightly different sample of companies.) In addition to these annual averages, a five-year national average was calculated for each ratio covering the 1985-89 period, and Analysis of Variance The discrepancy between what a party to a lawsuit alleges will be proved in pleadings and what the party actually proves at trial.
In Zoning law, an official permit to use property in a manner that departs from the way in which other property in the same locality (ANOVA anova
see analysis of variance.
ANOVA Analysis of variance, see there ) was used to identify significant differences between the performance of firms in each nation. Multi-year averages are frequently used for this purpose since they greatly reduce the impact of unique events which affect the performance of firms in a single country for a brief period of time, such as exchange rate volatility, political events, or the nation's position in the business cycle.
The Disclosure/Worldscope (D/W) database provides financial and operating information on over 3000 leading, industrial companies located in 24 countries, and contains roughly 1400 U.S., 480 Japanese, and 190 German firms in all major industries. In general, these firms represent the largest, publicly traded companies publicly traded company
A company whose shares of common stock are held by the public and are available for purchase by investors. The shares of publicly traded firms are bought and sold on the organized exchanges or in the over-the-counter market. in each country; and consequently, tend to generate a large portion of their revenue from foreign activities. Table 3 presents the 1989 average, Sales (in $millions), percent Foreign Sales, number of Employees, Total Assets (in $millions), Depreciation as a percentage of Net Plant and Equipment (NP&E), and Debt/Equity ratios Debt/Equity Ratio
A measure of a company's financial leverage calculated by dividing long-term debt by shareholders equity. It indicates what proportion of equity and debt the company is using to finance its assets. of all American, German, and Japanese firms contained in the D/W database. For the most part, the target firms in each country are closely matched, although German firms do appear somewhat larger than firms in the other two countries, and clear national differences are evident in average debt/equity ratios, levels of depreciation, and assets per worker.
Table 3. Characteristics of German, Japanese, and U.S. Firms in the D/W Database (for 1989) Germany Japan U.S. Sales ($ M) 4,035 3,359 2,173 % Foreign sales 70.1 24.1(*) 29.8 Employees 26,973 9,981 14,813 Assets ($ M) 3,095 3,599 2,233 Dep./net P&E 22.8 18.8 13.5 L.T. Debt/equity 25.9 54.9 66.0 * Figure for 1987.
Tables 4, 5, and 6 present the average annual operating margins, returns on assets, and returns on equity respectively for American, German, and Japanese companies between 1984 and 1990. In all cases, these averages represent the simple arithmetic mean (mathematics) arithmetic mean - The mean of a list of N numbers calculated by dividing their sum by N. The arithmetic mean is appropriate for sets of numbers that are added together or that form an arithmetic series. of a ratio for the 100 firms chosen from a particular country. Further, since both return on equity and return on assets are greatly affected by differences in tax rates between nations, annual adjusted averages have been calculated for these indicators which reflect a hypothetical Hypothetical is an adjective, meaning of or pertaining to a hypothesis. See:
n a statistical device used to determine the range within which an acceptable datum would fall. Confidence intervals are usually expressed in percentages, typically 95% or 99%. (based on the pooled standard deviation Pooled standard deviation is a way to find a better estimate of the true standard deviation given several different samples taken in different circumstances where the mean may vary between samples but the true standard deviation (precision) is assumed to remain the same. ) has been constructed around each national mean, and a summary of the Analysis of Variance (ANOVA) has been provided.
Based on this analysis, a number of interesting observations can be made. The most important of these are: 1) Over the five year period from 1985-89, significant differences were identified in the average annual operating margins and returns on assets of firms in each country, but not in their return on equity. Specifically, the five-year, average annual operating margin of German firms was about half that of Japanese and American companies; while the five-year, average annual return on assets for American firms was about twice that of similar German and Japanese companies. 2) After adjusting ROAs and ROEs to reflect differences in tax rates between countries, the significant difference in ROAs disappeared, and a significant difference in ROEs emerged. Specifically, the five-year, adjusted annual ROE for German companies was about 35% higher than the adjusted ROEs of similar American and Japanese firms. 3) In general, Japanese (and to a lesser extent German) firms exhibited far less variation in profitability than American firms, both over time and between companies. And 4) In most years, American firms both outperformed and underperformed the best and worst performing firms from Germany and Japan on all three profitability indicators. These findings are discussed in the following section.
TABULAR DATA OMITTED
This study identified statistically significant differences in the profitability of large American, German, and Japanese industrial companies in two of the three indicators employed. Perhaps the most important differences emerged in the operating margins of firms from each nation, where German firms consistently earned lower margins than their Japanese and American counterparts over the 1984-90 period. Based on five-year averages, German firms had annual operating margins only half those of Japanese and American companies; however, much of this difference stemmed stemmed
1. Having the stems removed.
2. Provided with a stem or a specific type of stem. Often used in combination: stemmed goblets; long-stemmed roses. from the extremely poor performance of German firms between 1987 and 1990. During this period, the average operating TABULAR DATA OMITTED TABULAR DATA OMITTED margins of German companies declined from roughly 6% to less than 1%; while Japanese margins remained stable at around 6%, and American operating margins declined in 1988, but quickly rebounded.
On the other hand, firms in all three countries appear to have broadly similar returns on assets and returns on equity. Over most of the 1984-90 period, the average annual ROAs of Japanese and German companies were 40-50% less than those of American firms, but much of this apparent difference is an artifact of differences in tax rates between the three countries. When ROAs are adjusted to reflect a common 50% effective tax rate in each nation, differences in the five-year, adjusted annual ROAs are no longer statistically significant. Instead, firms in all three countries appear to earn between 4-5% on assets, although Japanese firms generally reported slightly lower -- and American firms somewhat higher -- returns during the late 1980s.
No statistically significant differences were observed in the five-year, average annual returns on equity of firms in each nation; although Japanese firms generally earned somewhat lower returns than their American and German counterparts. On the other hand, when adjustments were made to reflect equivalent tax rates in each country, significant differences were found in the five-year, adjusted annual ROEs, with German firms achieving adjusted returns about 35% higher than similar Japanese and American companies. In general, the ROEs of German firms averaged roughly 12% between 1985-89, while the ROEs of Japanese and American firms averaged about 9% over this period.
This finding is difficult to explain since it was suggested that the greater use of debt in the U.S. and Japan would produce higher (not lower) ROEs. One possible explanation for this disparity dis·par·i·ty
n. pl. dis·par·i·ties
1. The condition or fact of being unequal, as in age, rank, or degree; difference: "narrow the economic disparities among regions and industries" is that Japanese and American companies are not earning enough on their invested capital to offset the additional interest expenses they must bear. However, operating margins in the U.S. and Japan were higher than in Germany over the period studied, while firms from all three countries earned roughly equivalent rates of returns on their assets. Further, even though interest expenses as a percentage of sales have been slightly higher for Japanese and American firms in recent years, these differences are not large. For example, between 1984-89, the average interest expense for German companies was about 1-1.5% of sales, compared with roughly 2-2.5% for Japanese firms, and 2.5-3.5% for U.S. companies. Another explanation for the difference in adjusted ROEs is that German companies generated a great deal of their incomes from sources other than operations, particularly after 1987. As a result, the operating margins of German firms have remained low, while measures of profitability based on net income have been substantially higher.
One of the study's most interesting findings is that all three profitability indicators exhibited far less variability -- both across firms and over time -- for Japanese and German firms than for similar American firms. Specifically, the standard deviations In statistics, the average amount a number varies from the average number in a series of numbers.
(statistics) standard deviation - (SD) A measure of the range of values in a set of numbers. of both the annual and five-year averages of all three profitability indicators were substantially lower for Japanese and (to a lesser extent) German companies than for their American counterparts. This is particularly remarkable given the extreme volatility of the yen (and to a lesser extent the Deutsche Mark) during the late 1980s, since one would expect firms in both countries to experience wide swings in revenues and earnings due to the uncertain effects of exchange rates on the yen and mark values of their foreign activities. A corollary corollary: see theorem. to this finding is that, in general, American firms generated both higher and lower rates of return than the best and worst performing Japanese and German companies in every year examined. Two factors may explain these findings. First, specific accounting practices in Japan and Germany which allow firms to "control" their reported incomes to some extent; and second, unique aspects of the institutional structures of both countries which create a more stable economic environment.
As noted above, various accounting practices allow firms in Germany and Japan to "smooth" fluctuations in their reported earnings to some extent. Particularly important in this regard are the widespread use of reserve funds and the cooperative nature of business relationships which could allow firms in both countries to maintain relatively stable rates of return even during periods of economic adversity ad·ver·si·ty
n. pl. ad·ver·si·ties
1. A state of hardship or affliction; misfortune.
2. A calamitous event. . However, an equally compelling explanation for the stability of returns in Germany and Japan involves several characteristics of these nations' economic and social climates. Perhaps the most important of these are: 1) the high degree of government participation in the development and promotion of long-term economic policies and objectives, 2) the greater degree of cooperation-both between business and government, 3) the close relationship between workers and managers, and the greater degree of worker participation, and 4) the ability of banks (and other corporations) to act as stable, long-term capital providers and shareholders in domestic companies. Taken together, these factors produce a far more stable economic and social environment in Germany and Japan than the U.S., which may ultimately translate into a generally lower level of risk (and hence the volatility of returns) being associated with business activities in the former countries. Added support for this rationale rationale (rash´nal´),
n the fundamental reasons used as the basis for a decision or action. comes from the fact that interest rates (a rough gauge of risk) have generally been much lower in Germany and Japan than in the United States in recent years.
Finally, it is useful to compare the findings of the current study with those of previous studies. Unfortunately, due to differences in methodologies and objectives, it is difficult to make definitive statements; however, two conclusions seem warranted. First, although American companies generally earned higher (nominal) rates of return than their German and Japanese counterparts, these differences were neither as large nor as consistent as the differences observed in earlier studies. Second, Haar's finding that the returns of American and European firms declined -- while the returns of Japanese firms increased -- from the late 1970s to the mid- mid-
Middle: midbrain. 1980s, appears to hold true for the late 1980s as well. Compared to Lee and Blevins' averages for the 1980-87 period, the profitability of large, U.S. industrial firms continued to decline during the latter half of the 1980s, while the profitability of Japanese firms continued to improve. This trend may represent the global equalization of returns hypothesized in the beginning of this paper, or it could reflect basic differences in corporate strategies between nations. The relatively high rates of capital investment and assets per worker seen in Germany and Japan in recent years may have contributed to the increased international competitiveness -- and hence improved performance -- of firms in both countries.
Perhaps the most important conclusion to emerge from this study is that the theoretical arguments developed in the beginning of this paper find some empirical support. At least for large firms that derive a substantial portion of their revenue from foreign activities (i.e. Multinational Enterprises), there seems to be only minor differences in the real performance of firms in the U.S., Germany, and Japan. In fact, based on the results of this study, operating margins in all three nations averaged between 4-6%, while pretax pre·tax
Existing before tax deductions: pretax income.
pretax adj [profit] → vor (Abzug der) Steuern ROAs averaged between 8-12%, and pretax ROEs averaged about 20% during the late 1980s. Further, even though statistically significant differences were observed in the operating margins and adjusted returns on equity of German, Japanese, and American firms, these differences were not exceptionally large. Much of the difference in operating margins stemmed from the poor performance of German firms between 1987-90; while adjusted ROEs for German firms were only about 35% above those of American and Japanese companies.
However, it is appropriate to ask to what extent these findings have been influenced by differences in accounting practices between the three countries. Notwithstanding the above discussion, accounting practices appear to have played only a minor role in these results. Aside from Japanese and German practices which allow firms to "control" their reported earnings to some extent, specific attempts have been made to reduce the impact of other important accounting differences. For example, ROAs and ROEs have been adjusted to reflect differences in tax rates between in three countries, and operating margins and ROAs are unaffected by differences in firms' financial structures. Further, rates of depreciation were broadly similar in all three countries over most of the period studied, while the effects of other accounting differences tend to counterbalance each other. Thus, these findings should provide a reasonably accurate assessment of the relative profitability of large firms in Germany, Japan, and the United States during the late 1980s.
A second major finding concerns the impact of accounting standards, business practices, and government regulations on the observed profitability of firms in different nations. In a very real way, profits and profitability are determined by the legal and accounting environments in which firms operate. This has two important implications. First, it makes it extremely difficult to accurately assess real firm performance, and even more difficult to compare the profitability of firms from different nations. But secondly, it suggests that governments and regulators can have a real impact on the operations and strategies of firms (both domestic and foreign) under their jurisdiction. This latter consequence is crucial because the activities of a nation's firms (and of foreign firms operating within a nation's borders) are a major determinant of economic welfare. Thus, governments must use tax and investment policies, special incentives and allowances, fees and regulations, among other things, in such a way that firms are encouraged to pursue strategies which not only generate acceptable rates of return, but also promote higher levels of employment, the efficient allocation of resources allocation of resources
Apportionment of productive assets among different uses. The issue of resource allocation arises as societies seek to balance limited resources (capital, labour, land) against the various and often unlimited wants of their members. and capital, and increased economic growth and welfare.
Finally, this study clearly illustrates the great complexity and multi-disciplinary nature of much International Business research. What began as a seemingly seem·ing
Outward appearance; semblance.
seeming·ly adv. straightforward investigation of the performance of firms in several countries, ultimately required a detailed understanding of specialized spe·cial·ize
v. spe·cial·ized, spe·cial·iz·ing, spe·cial·iz·es
1. To pursue a special activity, occupation, or field of study.
2. topics in Accounting, Finance, International Business, Management, and several other disciplines. Unfortunately, the author's limited knowledge has allowed only a cursory cur·so·ry
Performed with haste and scant attention to detail: a cursory glance at the headlines.
[Late Latin curs overview of many of these areas. Thus, while this paper has succeeded in identifying -- if not resolving -- a number of key issues involved in assessing performance across countries, the ultimately solutions to these problems must await AWAIT, crim. law. Seems to signify what is now understood by lying in wait, or way-laying. future research.
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