INTERNATIONAL BUSINESS

312 Part 3

Regional Economic Integration • Reseal”cll Task 0 globalEDGE ~.glob&11e!Jlge.mSll.edll

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Use the globalEDGETMsite to complete the following exercises;

Exercise 1

Your company is seekingto expandbyopeningnew cus- tomer· representative and sales offices in the European Union (EU), The size of the investment is significant, and top-management wishes to have adearer picture of the current and probable future status of the EU. A col- league who spent some time living in the ED indicated that Eurostat might be a comprehensive source to assist in yourproject, After evaluating the stateoftheEU

based on the statistics and publications available,. pre- . parean executive summary describing the features you

consider as crucial in completing your report.

Exercise 2·

.:Trade agreements can impact. The cultural interactions between countries; In fact, the establishment of the Free

• TradeArea of the Americas (ETAA) can be considered a . threat as well as an opportunity for your company. Iden- .tify the main negotiating groups a country must consider whena member. Choose two negotiating groups and jus-

.tify their importance to member countries.

NAfTA and Mexican Trucking When the North American Free Trade Agreement (NAFTA) went into effect in 1994, the treaty specified that by 2000 trucks from each nation would be allowed to cross each other’s borders and deliver goods to their ultimate destination. The argument was that such a pol- icy would lead to great efficiencies. Before NAFTA, Mexican trucks stopped at the border, and goods had to be unloaded and reloaded onto American trucks, a pro- cess that took time and cost money. It was also argued that greater competition from Mexican trucking firms would lower the price of road transportation within NAFTA. Given that two-thirds of cross-border trade within NAFTA goes by road, supporters argued that the savings could be significant.

This provision was vigorously opposed by the Team- sters union in the United States, which represents truck drivers. The union argued that Mexican truck drivers had poor safety records, and that Mexican trucks did not adhere to the strict safety and environmental standards of the United States. To quote James Hoffa, the presi- dent of the Teamsters:

Mexican trucks are older, dirtier, and more dangerous than American trucks. American truck drivers are taken off the road if they commit a serious traffic violation in their personal vehicle. That’s not so in Mexico. Limits on the hours a driver can spend behind the wheel are ignored in Mexico.

Under pressure from the Teamsters, the United States dragged its feet on implementation of the truck-

ing agreement. Ultimately the Teamsters sued to stop implementation of the agreement. An American court rejected their arguments and stated the country must honor the treaty. So did a NAFTA dispute settlement panel. This panel ruled in 2001 that the United States was violating the NAFTA treaty and gave Mexico the right to impose retaliatory tariffs. Mexico decided not to do that, instead giving the United States a chance to honor its commitment. The Bush administration tried to do just that, but was thwarted by opposition in Con- gress, which approved a measure setting 22 new safety standards that Mexican trucks would have to meet be- fore entering the United States.

– In an attempt to break the stalemate, in 2007 the U.S. government set up a pilot program under which trucks from some 100 Mexican transportation companies could enter the United States, provided they passed American safety inspections. The Mexican trucks were tracked, and after 18 months, that program showed the Mexican carri- ers had a slightly better safery record than their U.S. counterparts. The Teamsters immediately lobbied Con- gress to kill the pilot program. In March 2009 an amend- ment attached to a large spending bill did just that.

This time the Mexican government did not let the United States off the hook. As allowed to under the terms of the NAFTA agreement, Mexico immediately placed tar- iffs on some $2.4 billion of goods shipped from the United States to Mexico. California, an important exporter of agri- cultural products to Mexico, was hit hard. Table grapes now faced a 45 percent tariff, while wine, almonds, and juices

 

 

Regional Econormc Integration Chapter 9 313.;:-

<would pay a 20 percent tariff. Pears, which primarily come }from Washington state, faced a 20 percent tariff (4 out of 10 f.Je8i~that the United Scuee eKpaftS’ go to Merica). Other products hit with the 20 percent tariff include ex- ports of personal hygiene products and jewelry from New York, tableware from Illinois, and oil seeds from North Dakota. The u.s. Chamber of Commerce has estimated that the current situation costs some 25,600 U.S. jobs. The U.S. government said it would try to come up with a new program that both addressed the “legitimate concerns” of Congress and honored its commitment to the NAFTA treaty. What that agreement will be, however, remains to be seen, and as of 2010, there was no agreement in sight 50

Case Discussion Questions

!i’\ What are the potential economi~ benefits of the U trucking provisions in the NAFTA treaty? Who

benefits? 2. What do you think motivated the Teamsters to

object to the trucking provisions in NAFTA? Are these objections fair? Why did Congress align itself with the Teamsters?

3. Does it make economic sense for the United States. to bear the costs of punitive tariffs as al- lowed for under NAFTA, as opposed to letting Mexican trucks enter the United States?

1. O. Gibson, “Round One to the Pub Lady,” The Guardian, February 4,2011, p. 5; J. W. Miller, ”European TV Market for Sports Faces Turmoil from Legal Ruling,” The Wall Stxeet ioumol, February 4, 2011; andJ. Wilson, ”What the Legal Wmngle Means for Armchair Fans,” The Daily Tele- graph, February 4,2011, p. 8.

2. Information taken from World Trade Organization web- site and current as of February 2011, wwwwto.org.

3. Ibid. 4. The Andean Pact has been through a number of changes

since its inception. The latest version was established in 1991. See “Free-Trade Free for All,” The Economist, Janu- ary 4, 1991, p. 63.

5. D. Swann, The Economicsof the Common Market, 6th ed. (London: Penguin Books, 1990).

6. See J. Bhagwati, “Regionalism and Multilateralism: An Overview,” Columbia University Discussion Paper 603, Department of Economics, Columbia University, New York; A. de la Torre and M. Kelly, “Regional Trade Arrangements,” Occasional Paper 93, Washington, DC: International Monetary Fund, March 1992; J. Bhagwati, “Fast Track to Nowhere,” The Economist, October 18, 1997, pp. 21-24; jagdish Bhagwati, Free Trade Today (Princeton and Oxford: Princeton University Press, 2002); and B. K. Gordon, “A High Risk Trade Policy,” Foreign Affairs 82 no. 4 (July/August 2003), pp. 105-15.

7. N. Colchester and D. Buchan, Europawer: The Essential Guide to Europe’s Economic Transformation in 1992 (London: The Economist Books, 1990), and Swann, Eco- nomics of the Common Market.

8. A. S. Posen, “Fleering Equality, The Relative Size of the EU and US Economies in 2020,” The Brookings Institu- tion, September 2004.

9. Swann, Economicsof the Common Market; Colchester and Buchan, Europower: The Essential Guide toEurope’s Economic Transfo17T1ationin 1992; “The European Union; A Survey,” The Economist, October 22,1994; “The EuropeanCommunity:

A Survey,” The Economist, July 3, 1993; and the European Union website at http://europa.eu.int.

10. E. 1- Morgan, “A Decade ofEC Merger Control,” Interna- tional Journal of Economics and Business, November 200 1, pp.451-73.

11. W. Drozdiak, “EU Allows Vivendi Media Deal,” Washington Post, October 14, 2000, p. E2; D. Hargreaves, “Business as Usual in the New Economy,” Financial Times, October 6, 2000, p. 1; and D. Hargreaves, “Brussels Clears AOL- Time Warner Deal,” Financial Times, October 12, 2000, p.12.

12. “The European Community: A Survey.” 13. Tony Barber, “The Lisbon Reform Treaty,” FT.com,

December 13, 2007. 14. “One Europe, One Economy,” The Economist, Novem-

ber 30, 1991, pp. 53-54; and “Market Failure: A Survey of Business in Europe,” The Economist, June 8, 1991, pp.6-1O.

15. Alan Riley, “The Single Market Ten Years On,” European Policy Analyst, December 2002, pp. 65-72.

16. C. Randzio-Plath, ”Europe Prepares for a Single Financial Market,” Intereconomic, May-June 2004, pp. 142-46; T. Buck, D. Hargreaves. and P. Norman. “Europe’s Single Financial Market,” Financial Times, January 18, 2005, p. 17; “The Gate-keeper,” The Economist, February 19, 2005, p. 79; P. Hofheinz, “A Capital Idea: The European Union Has a Grand Plan to Make Irs Financial Markers More Efficient,” The Wall Street Journal, October 14, 2002,p. R4; and “Banking on McCreevy: Europe’s Single Market,” The Economist, November 26, 2005, p. 91.

17. See C. Wyploze, “EMU: Why and How It Might Hap- pen,” Journal of Econamic Perspectives 11 (1997), pp. 3-22; and M. Feldstein, “The Political Economy of the Euro- pean Economic and Monetary Union,” Journal of Eco- nomic Perspectives 11 (1997), pp. 23-42.

18. “One Europe, One Economy”; and Feldstein, “The Political Economy of the European Economic and Monetary Union,”

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Entry Strategy and Strategic Alliances Chaptert5 511

Entry strategy and Strategic Alliances

…Use the globalEDGETM site to complete thefollowing exercises:

Exercise 1

A vital element in a successful international market entry strategy is an appropriate fit of skills and capabilities .

• between partners, As such, the Entrepreneur magazine annually publishes a ranking of the “Top Global Franchises.” Provide a list of the top 1o companies that

. pursue franchising as a mode of international expansion. Study one of these companies in detail and provide a description of its business model, its international .. expansion pattern, desirable qualifications. in possible franchisees, and the support and training typically.

General Electric’s Joint Ventures Historically at General Electric, if you wanted to enter a foreign market, you either acquired an established firm in that market or you went alone, establishing a greenfield subsidiary. Joint ventures with a local company were almost never considered. The prevailing philosophy was that if GE didn’t have full control, you didn’t do the deal. However, times have changed. Since the early 2000s joint ventures have become one of the most powerful strategic tools in GE’s arsenal. To enter the South Korean market, for example, GE Money, the retail lending arm of GE’s financial services business, formed joint ventures with Hyundai to offer auto loans, mortgages, and credit cards. GE has a 43 percent stake in these ventures. Simi- larly, in Spain it has formed several joint ventures with local banks to provide consumer loans and credit cards to Spanish residents, and in Central America it has a joint venture with BAC-Credomatic, the largest bank in the region.

There are several reasons for the switch in strategy. For one thing, GE used to be able to buy its way into majority ownership in almost any business, but prices for acquisitions have been bid so high that GE is reluctant to acquire for fear of overpaying. Better to form a joint venture, so the thinking goes, than risk paying too much for a company that turns out to have problems that are discovered only after the acquisition. Just as importantly,

provided by the franchiser. Are there areas where improvement can be made for the company to maintain competitiveness? Provide sufficient justification for your. position.

Exercise 2

.. The U.S. Commercial Service prepares reports known as . the “Country Commercial Guide” for countries of interest

. to U.S. investors. Utilize the Country Commercial Guide for Russia to gather information on this country’s . energy and mining industry. Considering that your com- pany has plans to enter Russia in the foreseeable future, select the most appropriate entry. method. Be sure to support your decision with the information collected.

GE now sees joint ventures as a great way to dip its toe into foreign markets where it lacks local knowledge. Also, in certain nations, China being an example, eco- nomic, political, legal, and cultural considerations make joint ventures an easier option than either acquisitions or greenfield ventures. GE believes it can often benefit from the political contacts, local expertise, and business relationships that the local partner brings to the table, to say nothing of the fact that in certain sectors of the Chinese economy and some others, local laws prohibit other entry modes. GE also sees joint ventures as a good way to share the risk of building a business in a nation where it lacks local knowledge. Finally, under the leadership of CEO Jeffrey Immelr, GE has adopted aggressive growth goals, and it feels that entering via joint ventures into nations where it lacks a presence is the only way of attaining these goals. Fueled by its large number of joint ventures, GE has rapidly expanded its international presence over the past decade. For the first time, in 2007 the company derived the majority of its revenue from foreign operations.

Of course, General Electric has done joint ventures in the past. For example, it has a long-standing 50-50 joint venture with the French company Snecma to make engines for commercial jet aircraft, another with Fanuc of Japan to make controls for electrical equipment, and

 

 

512 Part 5 The Strategy and Structure of International Business

a third with Sea Containers of the United Kingdom, which has become one of the world’s largest companies leasing sliipping containers. But all of these ventures came about only after OE had explored other ways to gain access to particular markets or technology. While OE formerly used joint ventures as the last option, they are now often the preferred entry strategy.

OE managers also note that there is no shortage of partners willing to enter into a joint venture with the company. The company has a well-earned reputation for being a good partner to work with. OE is well known for its innovative management techniques and excellent management development programs. Many partners are only too happy to team up with GE to get access to this know-how. The knowledge flow, therefore, goes both ways, with OE acquiring access to knowledge about local markets, and partners learning cutting-edge management techniques from GE that can be used to boost their own productivity.

Nevertheless, joint ventures are no panacea. GE’s agreements normally give even the minority partner in a joint venture veto power over major strategic decisions, and control issues can scuttle some ventures. In january 2007, for example, GE announced it would enter into a venture with Britain’s Smiths Group to make aerospace equipment. However, nine months later, GE ended talks aimed at establishing the venture, stating they could not reach an agreement over the vision for the joint venture. GE has also found that as much as it would like majority ownership, or even a 50150 split, sometimes it has to settle for a minority

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stake to gain access to a foreign market. In 2003, when GE entered into a joint venture with :f1yundaj to offer auto loans, it did so as a minority partner even though it would have preferred a majority position. Hyundai had refused to cede control over to GE.63

Case Discussion Questions

1. GE used to prefer acquisitions or greenfield ventures as an entry mode rather than joint ventures. Why do you think this was the case?

2. Why do you think that GE has come to prefer joint ventures in recent years? Do you think that the global economic crisis of 2008-2009 might have affected this preference in any way? If so, how?

3. What are the risks that OE must assume when it enters into a joint venture? Is there any way for GE to reduce these risks?

4. The case mentions that GE has a well-earned reputation for being a good partner. What are the likely benefits of this reputation to GE? If GE were to tarnish its reputation by, for example, opportunistically taking advantage of a partner, how might this impact the company going

(s) forward?5. In addition to its reputation for being a good part- ner, what other assets do you think GE brings to the table that make it an attractive joint-venture partner?

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1. S. Schifferes, “Cracking China’s Car Market,” BBC News, May 17, 2007; N. Madden, “Led by Buick, Carmaker Learning Fine Points of Regional China Tastes,” Automotive News, September 15, 2008, pp. 186-90; “GM Posts Record Sales in China,” Toronto Star, January 5, 2010, p. B4; and “GM’s Sales in China Top US,” Investor’s Business Daily, January 25,2011, p. A1.

2. For interesting empirical studies that deal with the issues- of timing and resource commitments, see T. Isobe, S. Makino, and D. B. Montgomery, “Resource Commit- ment, Entry Timing, and Market Performance of Foreign Direct Investments in Emerging Economies,” Academy of Management Journal 43, no. 3 (2000), pp. 468-84; and Y. Pan and P. S. K. Chi, “Financial Performance and Survival of Multinational Corporations in China,” Strategic ManagementJauma120, no. 4 (1999), pp. 359-74. A complementary theoretical perspective on this issue can be found in V. Govindarjan and A. K. Gupta, The Quest for Global Dominance (San Francisco: [ossev-Bass,

2001). Also see F Vermeulen and H. Barkeme, “Pace, Rhythm and Scope: Process Dependence in Buildinga Profitable Multinational Corporation,” Strategic Manage”: mentloumal23 (2002), pp. 637-54. —

3. This can be reconceptualized as the resource base of thE:, . – entrant, relative to indigenous competitors. For work tlliIl; focuses on this issue, see W. C. Bogner, H. Thomas, arid- . ). McGee, “A Longitudinal Study of the Competitive Pos~ tions and Entry Paths of European Finns in the U.S. Phai;’ maceutical Market,” StrategicManagementJoumal17 (1996J; . pp. 85-107; D. Collis, “A Resource-BasedAnalysis of Globel ” Competition,” Strategic Management Journal 12 (199l)~ pp. 49-68; and S. Tallman, “Strategic Management ModelS; and Resource-Based Strategies among MNEs in a HO$f Market,” StrategicManagementJoumal12 (1991), pp. 69.-82}

4. For a discussion of first-mover advantages, st:;€:- M. Lieberman and D. Montgomery, “First-Mover Adv~i’·:> rages,” Strategic Management Journal 9 (Summer Speci~~(~ Issue, 1988), pp. 41-58. … ,-

 

 

548 Part 6 Business Operations

disadvantages of using export credit insurance rather than: a letter of credit for exporting (a)a .’ luxury yacht from California to Canada, and (b) machine tools from New York to Ukraine?

4. How do you explain the use of countertrade? Under what scenarios might its use increase fur-

ther by2015?Under what scenarios might its ‘. use decline?

5. How might a company make strategic use of countertrade schemes as a marketing weapon to generate export revenues? What are the risks as- sociated with pursuing such a strategy?

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Exporting, Importing, and Countertrade

Use the globalEDGPM site to complete the following exercises:

Exercise 1

Exporting is an important way for small and large compa- nies to introduce products and develop new markets. In fact, the Internet is rich with ‘resources that offer guidance to companies wishing to expand their markets through exporting. The trade tutorials at the globalEDGE website provide links to these resources. Identify five sources and provide a description of the services avail- able for new exporters through each source.

Exercise 2

Understanding the specific terminology used in CH~_ …:’ _ import/export process is necessary prior to ny’s first international venture. Utilize the glclhalE1DCJE Glossary of International Business Terms to identify

. definitions of the following terms related to exporting.’: .,·•••• and importiug:ad valorem tariff, consignment, embargo.,: global quota, invisible barriers to trade, letter of mercantilism, and section 201.

Mil International Al Merritt founded MD International in 1987. A former salesman for a medical equipment company, Merritt saw an opportunity to act as an export intermediary for med- ical equipment manufacturers in the United States. He chose to focus on Latin America and the Caribbean, a region that he already had experience in. Also, trade barriers were starting to fall throughout the region as Latin governments embraced a more liberal economic ideology, creating an opening for entrepreneurs such as Merritt. Local governments were also expanding their spending on health care, creating an opportunity that Merritt was poised to exploit.

Merritt located his company in south Florida to be close to his market. Since then, the company has grown to become the largest intermediary exporting medical devices to the region. Today the company sells the prod- ucts of more than 30 medical manufacturers to some 600 regional distributors. While many medical equip-

ment manufacturers don’t sell directly to the region . because of the sizable marketing costs, MD can afford to because it goes into those markets with a broad portfolio of products.

The company’s success is in part due to its deep- rooted knowledge and understanding of the Latini American market. MD works very closely with teams of doctors, biomedical engineers, microbiologists, and mar~:’ keting managers across Latin America to understand_Y their needs and what the company can do for them. The> sale of products to customers is typically only the begin- ….. ning of a relationship. MD International also provides training to medical personnel in the use of devices and’ extensive after-sale service and support. ..

Along the way to becoming a successful exporter, MD’ International has leaned heavily upon export assistance ….. programs established by the U.S. government. For ex-‘ ample, in the early 2000s a shipment to Venezuela was

 

 

Exportma Importing, and Countertrade

held up by the Venezuelan customs seeking proof that the medical devices were not intended for military use. Within two days, staff at the U.S. Export Assistance Center in Miami arranged for the U.S. embassy in Venezuela to have a letter written and delivered to the customs officials, assuring them that the products had no military applications, and the shipment was released. Merritt has also worked extensively with the Expon- Import Bank to gain financing for its exports (the corn- pany needs to finance the inventory that it exports).

Despite these advantages, it has not all been easy going for MD International. Latin American economies have often been highly cyclical, and MD International has ridden those cycles with them. In 2001, for example, after several years of solid growth, an economic crisis in both Argentina and Brazil, coupled with a slowdown in Mexico, resulted in losses for the year and forced Merritt to lay off one-third of his staff and cut the pay of others, which included a 50 percent pay cut for himself. Things started to improve in 2002, and the weak dollar in the mid- 2000s also helped to boost expon sales. However, the global financial crisis of 2008 ushered in another tough period; although prior experience suggests that

Chapter 16 549

MD International can not only survive such downturns, but also come out stronger as weaker competitors fall by the wayside.”

Case Discussion Questions

1. How does an intermediary such as MD Intema- tiona Icreate value for the manufacturers that use it to sell medical equipment in fQreign mar- kets? Why do they want to use MD, Interna- tional rather than export directly themselves?

2. Why did MD International focus on Latin America? What are the benefits of this regional approach? What are the potential drawbacks?

3. What would it take for MD International to start exporting to other regions such as Asia or Europe? Given this, would you advise Al Merritt to continue his regional focus going forward or to add other regions?

~ How important has government assistance been l:J to MD International? Do you think helping

firms such as MD International represents good use of taxpayer money?

1. u.s. Department of Commerce website, “Vellus Products Inc.,” www.export.gov; C. K. Cultice, “Best in Show: Vellus Products,” World Trade, January 2007, pp. 70-73; and C. K. Cult ice, “Lathering up World Markets,” Busi~ ness America,” July 1997, p. 33.

2. R. A. Pope, “Why Small Firms Export: Another Look,” journal. of Small Business Management 40 (2002), pp. 17-26.

3. M. C. White “Marlin Steel Wire Products,” Slate Magazine, November 10, 2010.

4. S. T. Cavusgil, “Global Dimensions of Marketing,” in Marketing, ed. P. E. Murphy and B. M. Enis (Glenview, 1L: Scott, Foresman, 1985), pp. 577-99.

5. S. M. Mehta, “Enterprise: Small Companies Look to Cul- tivate Foreign Business,” The Wall Stseex Ioumol, July 7, 1994, p. B2.

6. P. A. Julien and C. Ramagelahy, “Competitive Strategy and Performance of Exporting SMEs,” Entrepreneurship Theory and Practice, 2003, pp. 227-94.

7. W. J. Burpitt and D. A. Rondinelli, “Small Firms’ Motiva- nons for Exporting: To Earn and Learn?” Journal of SmaU Business Management, October 2000, pp. 1-14; and J. D. Mittelstaedt, G. N. Harben, and W. A. Ward, “How Smaills Too Small?” Journal of SmaLl Business Management 41 (2003), pp. 68-85.

8. Small Business Administration, “The State of Small Business 1999-2000: Report to the President,” 2001; www.sba.gov/advo/stats/stateofsb99_00.pdf;and D. Ransom, “Obama’s Math: More Exports Equals More Jobs,” The Wall Street Journal. February 6, 2010.

9. A. O. Ogbuehi and T. A. Longfellow, “Perceptions of U.S. Manufacturing Companies Concerning Exporting,” Journal of Small Business Management, October 1994, pp. 37-59; and U.S. Small Business Administtation, “Guide to Exporting,” www.sba.gov/oit/info.Guide- to Exportlng/index.html.

10. R. W. Haigh, “Thinking of Exporting!” Columbia Joumal of World Business 29 (December 1994), pp. 66-86.

11. F. Williams, ”The Quest for More Efficient Commerce,” Financial Times, October 13, 1994, p. 7.

12. ]. Sparshott, “Businesses Must Export to Compete,” The Washington Times, September 1, 2004, p. C8; “Entrepre- neur of the Year 2001: Donald Gallion, FCX Systems,” The State Journal, June 18, 2001, p. SlO; and T. Pierro, “Exporting Powers Growth of FCX Systems,” The State Journal, April 6, 1998, p. 1.

13. See Burpitt and Rondinelli, “Small Firms’ Motivations for Exporting”; and C. S. Katsikeas, L. C. Leonidou, and N. A. Morgan, “Firm Level Export Performance Assessment,” Academy of Marketing Science 28 (2000), pp. 493-511.

 

 

dispersed supply chain. What are the causes of these problems? What can a company like Boeing do to make sure such problems do not occur in the future?

3. Some critics have claimed that by outsourcing so much work, Boeing has been exporting American jobs overseas. Is this criticism fair? How should the company respond to such criticisms?

Cases 669

1. J. L Lunsford, “Jet Blues,”The Wall Street]oumal, December 7,2007, p. AI; J. Gapper, “A Cleverer Way to Build a Boe- ing,” FinancialTimes,July 9, 2007, pLl.]. Teresko, “The Boeing 787: A Matter of Materials,” Industry Week, Decem- ber 2007, pp. 34-39; and P Sanders, “Boeing Takes Control of Plants,” The Wall Street}oumal, December 23, 2009, p. B2.

“,S~~IO- Adopting International! Accmultil!!g Stlilndardll T Following a European Union mandate, from January 1, 2005, onward, some 7,000 companies whose stock is pub- licly traded on European stock exchanges were required to issue all future financial accounts in a format agreed upon by the International Accounting Standards Board (IASB). In addition, some 65 countries outside of the EU have also committed to requiring that public companies issue accounts that conform to IASB rules. Even American accounting authorities, who historically have not been known for cooperating on international projects, have been trying to mesh their rules with those of the IASB.

Historically, different accounting practices made it very difficult for investors to compare the financial statements of firms based in different nations. For example, after the 1997 Asian crisis, a UN analysis concluded that before the crisis two-thirds of the 73 largest East Asian banks hadn’t disclosed problem loans and debt from related parties, such as loans between a parent and its subsidiary. About 85 per- cent of the banks didn’t disclose their gains or losses from foreign currency translations or their net foreign currency exposures, and two-thirds failed to disclose the amounts they had invested in derivatives. Had this accounting in- formation been made available to the public-as it would have been under accounting standards prevailing at the time in many developed nations-it is possible that prob- lems in the East Asian banking system would have come to light sooner, and the crisis that unfolded in 1997 might not have been as serious as it ultimately was.

In another example of the implications of differences in accounting standards, a Morgan Stanley research project found that country differences in the way corporate pension expenses are accounted for distorted the earnings state- ments of companies in the automobile industry. Most strik- ingly, while U.S. auto companies charged certain pension costs against earnings and funded them annually, Japanese auto companies took no charge against earnings for pension costs, and their pension obligations were largely unrecorded. By adjusting for these differences, Morgan Stanley found that the U.S. companies generally understated their earn- ings, and had stronger balance sheets, than commonly sup- posed, whereas Japanese companies had lower earnings and weaker balance sheets. By putting everybody on the same

I

footing, the move toward common global accounting stan- dards should eliminate such divergent practices and make cross-national comparisons easier.

However, the road toward common accounting stan- dards has some speed bumps. In November 2004, for ex- ample, Shell, the large oil company, announced that adopting international accounting standards would reduce the value of assets on its balance sheet by $4.9 billion. The reduction primarily came from a change in the way Shell must account for employee benefits, such as pensions. Similarly, following IASB standards, the net worth of the French cosmetics giant L’Oreal fell from 8.1 billion to 6.3 billion euros, primarily due to a change in the way certain classes of stock were classified. On the other hand, some companies will benefit from the shift. The UK-based mobile phone giant Vodafone, for example, announced in early 2005 that under newly adopted IASB standards, its reported profits for the last six months of 2004 would have been some $13 billion higher, primarily because the com- pany would not have had to amortize goodwill associated with previous acquisitions against earnings. 1

3.

What are the benefits of adopting international accounting standards for (a) investors and (b) business enterprises? What are the potential risks associated with a move in a nation toward adoption of international accounting standards? In which nation is the move to adoption of IASB standards likely to cause revisions in the reported financial performance of business enterprises, the . United States or China? Why?

1. E. McDonald, “What Happened?” The WalLStreet]ournaI, April 26, 1999, p. R6; P.Grant, “IFRS Boosts Vodafone Profits by Sterling 6.8 Billion,” Accounrancy Age, January 20, 2005; and G. Hinks, “IFRS to Wipe $4.7 billion off Shell’s Balance Sheet,” Accountancy Age, November 23,2004.