ABSTRACT INVESTMENT POLICY AND PERFORMANCE OF U.S. SUBSIDIARIES IN INDIA BY Daya Ram Singh This study is an examination and evaluation of the investment policies and performance of U.S. (manufacturing and petroleum) subsidiaries in India. The basic approach, based on published financial data, questionnaires and in- terviews, is to compare the investment policies and perfor- mance (profitability and risk) of the U.S. subsidiaries with their parent corporations. From a total population of 37 U.S. subsidiaries eligible (widely-held corporate subsidiaries, with at least 10% American equity investment, operating throughout the 1963-67 period) for the present study, the annual reports of 27 U.S. subsidiaries were made available for the years 1963 to 1967. These participating subsidiaries accounted for about 90% of the total assets, net worth and total sales of total population and constituted a reasonable cross-section view in terms of nature of products, age, ownership, management and size. To get more information r995411111119 the objective of investment, the application of Daya Ram Singh capital budgeting approach in international investment, etc., all of these 27 parent corporations were contacted through the questionnaire. Fourteen returned the completed ques- tionnaire. Personal interviews were conducted in the case of eight U.S. corporations. Before comparing the investment policy and perfor- mance of the subsidiaries with their parent corporations, the financial statements of the participating subsidiaries were adjusted for the price level changes in India. The U.S.A. also experienced some inflation during the period under study and the adjustment process followed for the U.S. subsidiaries allowed for this also. The adjusted financial statements of the subsidiaries were used as the basis for the present study. Study of comparative financial ratios indicated that the subsidiaries' investment policies differed from their parents in the following ways. Subsidiaries had rel- atively more investment in net fixed assets and inventories than their parent corporations while the parents, of course, had invested relatively more in cash, marketable securities, and accounts receivable. Regarding comparative financial structures, most striking was the subsidiaries' lesser re- liance (even among those well established) on retained earnings asia capital source. Consistent with this, the U.S. subsidiaries in the study, on the whole, paid a higher percentage of their earnings as dividends than did their Daya Ram Singh parent corporations. Their payout ratios were noted to be similar to those of other Indian public limited companies. However, there were greater fluctuations in the high and low dividend payout ratios of the subsidiaries than their parent corporations. One hypothesis tested was that the performance (rate of return, considering risk) of the Indian subsidi- aries is greater than their American parent corporations. The findings of the research indicate that the five-year average rates of return on total assets and on net worth of subsidiaries were less than their parents: returns. On the other hand, the subsidiaries' return on total sales generally exceeded those of their parent corporations. However, the well established subsidiaries were earning higher rates of return on net worth than their parent corporations. These two empirical evidences, i.e., higher rate of return on“ total sales and on net worth (well established subsidiaries) suggest that the U.S. subsidiaries were able to operate efficiently and earn higher profit in the long run. The optimistic attitude of the parent corporations, as revealed by the questionnaire survey and personal interviews, regard- ing their future plan in India also supports the above findings. Moreover, the period of the present study (1963- 67) exhibits unusual features of the Indian economy such as inflation, drought, acute :flmmi shortage, border conflicts with neighboring countries, recession in industrial production, Daya Ram Singh postponement of Fourth Plan, political instability, etc. On the other hand, 1963-67 was unusually good period for the U.S. economy. With the normal situation in India, there is greater possibilities for the better performance of the subsidiaries. The business risk, as evidenced by profit variability, of all subsidiaries (either higher or lower rate of return) was greater than for their parent corporations. Despite their subsidiaries' earnings variability, the parent cor- porations were more concerned, as revealed by the question- naire survey and personal interviews, with the environmental or non-business risks, i.e., currency exchange risk, politi- cal risk and economic risk. The parent corporations feel that the Indian currency exchange risks are minimal while political risks have increased. Uncertainties of procuring raw materials, changes in the priorities of Indian government economic policies and the rate of inflation were viewed as important factors affecting the attitude of the U.S. cor- porations regarding economic risks of the country. To minimize the various environmental risks, the parent corpora— tions indicated that they took various measures such as guarantee of risk by the U.S. Government, minimum equity investment, joint venture between U.S. corporations and Indian investors, etc. The present study is limited by the inability to incorporate transfer pricing, management fee, royalties, etc., Daya Ram Singh in studying the performance of the U.S. subsidiaries. However, the evidence did seem substantial that in general the subsidiaries' earnings were less than the parents', this in addition to greater risks. Yet many of the U.S. subsidiaries are fairly new. There seemed to be evidence that with maturity of the subsidiaries (and assuming an improvement in the economic situation of India and continua- tion of a reasonable foreign investment climate) the perfor- mance of the U.S. subsidiaries in the long run will improve, becoming consistent with the parents' risk-return expectations. INVESTMENT POLICY AND PERFORMANCE OF U.S. SUBSIDIARIES IN INDIA BY Daya Ram Singh A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1969 (9 Copyright by DAYA RAM SINGH 1970 ACKNOWLEDGMENTS I wish to express my deep appreciation to Dr. Adolph E. Grunewald, Chairman of my Doctoral Commit- tee, for his encouragement, moral support and guidance in the preparation of this dissertation. A great measure of thanks is also due to my other committee members, Dr. George C. Mead and Dr. Dole A. Anderson, for their valuable assistance and many hours of careful critical reading of the manuscript. Sincere thanks go to Dr. James Don Edwards, Chairman of the Department of Accounting and Financial Administration, for his encouragement throughout my doc- toral program at Michigan State University. I am also thankful to Dr. S. K. R. Bhandari, Dean, Faculty of Com- merce, Banaras Hindu University (India) for his confidence in me and for his encouragement to complete the doctoral program. The financial support provided by the Office of Dean, Graduate School of Business Administration, Michigan State University, is gratefully acknowledged. The Insti- tute for International Business and Economic Deve10pment Eitudies provided the much needed financial assistance ummmm we» pap npuppmfl .mocmcflm can .mpuhpma Amanucozv mocmunsu co unomwm “mouoom mmnn H.mou n.mmmu p.m~vu ~.mvvu o.Hmv p.mnen «.mpan p.mwn 66669 m0 mocmfipm umz .o AmHH p.mHH m.pam «.mmn m.mmp p.0pp H.~vp a.mop p.006 uuomxm .n omma s.no~ H.0H4H o.m¢ma m.mmma m.HmHH p.amoa p.HNHH «.msn ~.omp uuomsH .6 “confides OH .mmv momma .OH n e.mnw >.mv~ m.mom H.mm~ m.nmm p.mom v.mom N.m~oaxcoflaafls 0H .ms m>ummmm mmcmsoxm cmflmuom .m Hmmm m.mmmv «.mmmv m.omo¢ H.~mnm o.oamm m.mvom p.mpm~ o.sa~m o.paomlcoflaafls 0H .mmv peansd ms» QUH3 hammsm mono: .m mam Hma nma nma Hma ANH «ma pm Hoa Aooanmqmae mmUHHm ngmCOU . m. «.mam N.Hma s.mma m.mma m.sma H.mma m.e~a m.mm u Aooaummummmae mmOHHm mammmaonz .o n u «.mma «.mva 4.5ma m.v¢a m.mea m.paa p.mm Aooanpmmav GOHDOSOOHA HMHDDHOOHuma .m u p.HmH o.nsa m.mpa p.~ma o.ava H.oma m.am m.ms Aooaupmma xmch Hmumcmoe COHDODOOHA amanumOOcH .v I I o.AHm H.Hom v.mmm m.vm~ «.mmm m.spm m.sem Ammmmsu cal Ammoflpm meumvma ape OEOOGH muflmwu Mom .m u u m.oma A.mma H.mma p.0ma m.sma m.¢oa m.mm Acoflaafls oooa .mmv immense mvumvma ape usmuso Hmcoflupz umz .m u u pm.mmv mm.pmv mm.mpe mm.qu H¢.mmv mm.mmv u mo.apm Amcoflaaflsv conupasmom .H OH m n p m e m m H me up mp 4p mm mm am pm Hm amuH lemma uppma nepma -mpmH ummma uaoma nomma nmmmfi nomad .HuN mHflwP 22 The total outlay of the Third Plan was Rs. 104 billion--Rs. 63 billion for the public sector and Rs. 41 billion for the private sector. Thus the total outlays of the Third Plan was bigger than those Of the First and Second Plans put together. The achievements Of the Third Plan and the various problems encountered during this period have been described, in detail, under the caption 'Major Economic Development During 1962-67.' 1.2.3 Fourth Five-Year Plan.--In order to assess the various difficulties and problems experienced by the country during the period of Third Plan, the Government Of India decided to postpone the commencement of the Fourth Plan for a period Of three years. In April 1969, 'Uua Fourth Plan was started as 'growth with stability' the main aim of the Plan. The Fourth Plan expects a growth rate of 5% and 8-10% per annum, respectively, in tike agricultural sector and industrial sector during the FOurth Plan period.5 :L-3 Major Economic Development (1962 to 1967) The Indian economy witnessed, during these six Years, a number of significant and unexpected changes and deVelopments unparalleled in the history of the country's 5Planning Commission, Government of India, A roach $§Lthe Fourth Five-Year Plan, (New Delhi) May 1968, p. 1. 23 planned economic development. The whole period was marked with the various stresses and strains, one after another, on the Indian economy. The major events of the Indian economy during this period may be summarized as stagnation in the agri- cultural production and acute food shortage due to severe drought for the two successive years (1965 and 1966), Chinese aggression in 1962 and border conflict with Paki- stan in 1965, substantial increase in money supply due to increase in government expenditure on defense and devel- opment, continuous drain on froeign exchange reserve of the country and devaluation of Indian currency on June 6, 1966, suspension of foreign aid by the major countries, recessionary trend in the industrial production, contin- IKNJS pressure on the general price level, etc. The fol- lxnving discussion is based on Table 2:1. 1.3.1 Price Level.--The index number Of whole- sale price increased from 125.1 in 1961-62 (1952-53 = 1430) to 212.4 in 1967-68, i.e., an increase of about 72% 111 these years. The increase has been continuous through— CNIt these years. Moreover, the rise in the index of food articles was higher than that Of the increase in the index of wholesale prices. The same inflationary trend was noticeable in the case of consumer prices and the index of consumer prices increased from 127.0 in 1961-62 (1949 = 100) to 213.0 in 1967-68. 24 1.3.2 Agricultural Production.--Although India is trying to industrialize as soon as possible agriculture is still the mainstay of two-thirds of the population. Moreover, agriculture and allied activities provide half of the national income of the country. Besides this, it provides raw materials for some industries and is an im- portant source Of exports. Despite its critical position, the agricultural outputs could not increase and it was more or less stagnant during these years. The index of agricultural production declined from 144.8 in 1961-62 (1950 = 100) to 137.4 in 1962-63. In 1963-64 it showed a recovery trend but this trend, however, could not con- tinue for a long time. In 1965-66 the agricultural out- puts were the lowest since 1960-61 (Table 2:1). The Situation improved in the later part of 1967-68. The Stag'nation was mainly due to the less emphasis placed on the agriculture in the Second Plan and the failure of "KNJSOOD for the successive two years (1965 and 1966). 1.3.3 Industrial Production.--An examination of the index number of the rate of growth of industrial Production reveals that the annual rate of growth in in- dustrial production showed a declining trend since 1963. Between 1961 and 1963 the rate of growth was between 8.4% and 9.4%. From 1964 it started decreasing and reached to the lowest point of 1.4% in the year 1967. 25 Among the major industrial groups, the rate of growth in Basic Industries declined from 15.5% in 1962 to 2.8% in 1964. In 1965, it showed a recovery trend but again decreased to 2.1% in 1967. The rate of growth of Capital Goods increased from 9.0% in 1961 to 24.4% in 1964 and declined to 1.0% in 1967. In the case of Inter- mediate Goods the fall in the growth rate of output was gradual, i.e., 8.8% in 1962 to 5.4% in 1965, thereafter it declined sharply to 1.3% in 1966. However, it showed a recovery trend in 1967. The growth rate in the case of Consumer Goods fluctuated widely, i.e., an increase from 2.2% in 1962 to 7.5% in 1964 and then declining to -3.5% in 1967. Table 2:2 shows this picture. Table 2:2.--Annua1 rate of growth in industrial production in India, 1961-67 (in percentages). Year All Basic Capital Intermediate Consumer _‘__¥ Industries Industries Goods Goods Goods 11961 8.4 12.7 9.0 4.5 7.5 11962 8.4 15.5 16.6 8.8 2.2 1963 9.4 14.5 13.5 8.4 5.4 1964 6.3 2.8 24.4 7.4 7.5 1965 5.8 6.0 10.6 5.4 3.4 1966 2.4 5.2 2.2 1.3 0.7 1967 1.4 2.1 1.0 8.9 -3.5 ¥ Source: Reserve Bank of India Bulletin, July 1968, p. 863. 26 The decline in the production of industrial goods is mainly due to the fall in agricultural production causing a fall in the output of agro-based manufacturing industries and the decline in the import of raw materials needed for some major industries. The slow-down of in- vestment in the public sector also affected, to some ex- tent, the growth of industrial production. But the impact of these factors was not uniform in all the industries. Some industries suffered to a greater extent than the others. 1.3.4 Money Supply.--The money supply with the public increased from Rs. 30.4 billion in 1961-62 to Rs. 53.5 billion in 1967-68, i.e., an average increase of Rs. 3-3 billion in each year (Table 2:1). The increase in the money supply was mainly due to the greater increase ill the government expenditure on defense after the Chinese aggression in 1962 and the border conflict with Pakistan 1J1 1965. The increase in the government expenditure on tlhe developmental activities was also responsible for the substantial increase in the money supply. 1.3.5 Balance of Payment.--The imports of the Country increased from Rs. 10.9 billion in 1961-62 to Rs. 20.7 billion in 1966-67 whereas the export could not increase substantial. It increased from Rs. 6.6 billion in 1961-62 to Rs. 11.5 billion in 1966-67 (Table 2:1). The volume of imports increased because of the import of 27 substantial foodgrains to meet drought situation and the nmch needed machinery and raw materials for the indus- trialization of the country. Thus, the net balance of trade was always deficit in these years and this had a continuous pressure on the foreign exchange reserve of the country. The reserve declined from Rs. 10.2 billion in 1950-51 to Rs. 2.9 billion in 1965-66. In 1966-67, it increased to Rs. 4.7 billion (Table 2:1). To promote the exports of the country, the govern— ment adopted many promotional measures but their over-all result was not encouraging and hence the government decided to devalue the Indian currency by 36.5% on June 6, 1966. THKB devaluation of the currency intensified the inflationary Pressure on the economy. To meet the above situation the Government of India took a number of corrective steps to Create a condition in which steady planned growth with relative financial stability could take place. The im- ENthant measures include the postponement of Fourth Plan, decrease in deficit financing, abolition of food subsidies 'bo state governments, economies in budgetary expenditure, etc» During the closing months of 1967, the Indian economy started showing the signs of recovery. The unexpected good harvest of foodgrains and a fall of 6% in the general level of price have provided a right environment for the recovery 0f the Indian economy. 28 (2) Political Situation Since the attainment of political independence in 1947, India adopted the democratic form of government. The country had four general elections, i.e., in 1952, 1957, 1962 and 1967. In each general election the voters have shown increasing interest in the democratic system and the turnout of the voters increased from 45% in first general election to 46.6% in second, 55.4% in third and as high as 61% in last general election. Prior to the fourth general election, the country has a strong and stable government both at national and state levels. The political scene of India has signifi- cantly changed in 1967 as a result of the fourth general election. The politically dominating and the ruling party of the country since the independence, the Congress Party, suffered an unprecedented setback in this election and its najority has been significantly reduced at the national level and in the many states it could not form the govern— ment. In some states, a coalition of opposition parties formed the government but there is lack of cohesion in non-Congress groups. Besides the Congress Party, there is not a single strong opposition party which can be con- sidered as the alternative to the Congress Party. The above situation has provided instability to the human political system and doubts are being expressed re- garding the very basic foundation of the Indian democracy. 29 But there are certain inherent and orderly factors in the Indian democracy which continue to provide basic strength. First and most elementary is a majority party in parliament which has enabled the Congress ministry to provide at least minimal stability at the national level. The Union government and the parliament, as a consequence, have been able to respond to crises at the state level within the constitutional framework. Second, the federal framework has provided viable deSpite the stresses exacerbated by the weaking of the Congress Party and non-Congress governments at the state level. Finally, and most important, is the underpinning to the system provided by the main- tenance of democratic values for c0ping with politi- cal problems.6 Some political scientists feel that the fourth general election has made a real contribution to the Indian democracy and is considered the 'second Indian revolution' which will be embedded in the end in a party or parties with popular appeals which the Congress Party is losing but which other parties have not yet been able firmly to obtain.7 There are others who feel that the fourth general election has given uncertainty to the political situation in India. Norman D. Palmer, an expert on the Indian poli- tical situation, feels that "as the Indian political ex- periment enters a new phrase portents of trouble ahead and 6Paul Wallace, "India: The Leadership Crisis," Asian Survey (Berkeley, California), February, 1969, Vol. IX, No. 2, p. 80. 7Eric da Costa, "Poll Results Hearald Second Indian Revolution," The Statesman, March 9, 1967. a! CPS ‘.Ilu ' I GNQ' '1 ! o‘v‘ u ‘0. Iv' ‘7. pg...‘ .mvgadu I DD! V 4~ .6 In. ..-I. ‘ 4 '01:“... n 0"! : "n‘. .A..PP- 'Vu..~ ~ 1 1'” a. H be. p i": n “‘7‘. .- u ‘ 5». i~ b‘. - \‘f-v... h.“-‘ §-- ‘ u u.» 4 N“ U“ a .,‘ ~.' “- ~ ~“ :. .‘O- :‘a ‘.‘ ~_“ 'v‘. 30 signs of an increasingly effective participatory democ- racy appear in kaleidoscopic confusion, giving an atmos- phere of uncertainty and excitement to the changing Indian scene."8 Besides the instability of government at the state level, there are other political problems which India is facing. Among these, the most important may be mentioned the regional differences among the pe0ple of India, occa- sional communal disturbances, conflict between the indus- trial labor and the management, language difference and controversy, etc. The Chinese aggression in September 1962 and the border conflict with Pakistan in September 1965 have provided another dimension to the political situation of the country. Despite these problems, India is able to stand these pressures, because India's leadership is among the most sophisticated in the economically underdeveloped world and its intellectual elite the largest. The Indian Civil Service (now Indian Administrative Service) has a proud, if paternalistic, tradition of competence and in- tegrity. . .the present level of administrative morality and reliability is far above average for an underdeveloped country.9 8Norman D. Palmer, "India's Fourth General Elec- tion," Asian Survey, May 1967, Vol. VII, No. 5, p. 291. 9John P. Lewis, op. cit., p. 4. 31 (3) Financial Situation Since the achievement of the political independence in 1947 and particularly with the greater emphasis on the industrialization in the Five-Year Plans, the country has been facing the difficult problem of raising adequate funds to meet financial requirements of industry. A brief description of Indian capital market would provide some idea about the situation. 3.1 Indian Capital Market The Indian capital market can be broadly divided into three parts, i.e., organized sector, semi-organized sector and unorganized sector. The organized sector com- prises well-deve10ped banking system, stock exchanges, financial institutions, etc., whereas the unorganized sector consists of indigenous banking system and money lenders. The semi-organized sector includes cooPerative banking and other agencies. The unorganized sector of the Indian capital market was more or less isolated from the organized sector for a long time but the growing cooperative credit organization in semi-organized sector is becoming the connecting link between the organized and unorganized sections of the capital market. The organized sector of the Indian capital market is well-developed and "the organization of the Indian capital market does not compare unfavorably with '- ’- . . -\- 32 that of some of even the deve10ped countries. . . ."10 The Indian joint stock companies (including foreign sub- sidiaries) mainly deal with the organized section of the capital market. 3.1.1 Banking System.--The Indian banking system consists of the Reserve Bank of India (central bank of the country), the State Bank of India (a government-owned commercial bank) and a large number of the "scheduled" and "non-scheduled" banks (as defined below). The Reserve Bank of India is the central bank of the country and its primary function is to regulate mone- tary system of the country so as to promote stability and growth of the economy within the framework of the govern- ment's general economic policy. The over-all functions include regulation of currency and credit, supervision and control of banks, acting as the bank of government, opera- tion of foreign exchange control, etc. The State Bank of India started as a private bank but was nationalized by the government. Now government- owned, it is the largest commercial bank and has more than 500 branches all over the country. It accounts for about 30% of the net deposits of all scheduled banks. 10George Rosen, Some Aspects of Industrial Finance in India, (The Free Press of Glencoe) 1962, p. 1. a 33 The scheduled banks are those banks which are in- cluded in the 'Second Schedule' of the Reserve Bank of India Act. The conditions for a bank to be included are (1) that it should have a paid-up capital and reserves of an aggregate value of not less than Rs. 500,000; and (2) that it should satisfy the Reserve Bank that its affairs are not being conducted in a manner detrimental to the interest of its depositors. The scheduled banks including State Bank conduct almost all the banking business in India and account for 90% of total deposits of all the scheduled banks (including State Bank) of India. The remaining 10% is the share of foreign scheduled banks in India. Some of the scheduled banks are fairly large having branches all over the country. Recently the government of India has nationalized 14 biggest scheduled banks (excluding foreign banks) of the country. Besides these banks, there are a large number of non-scheduled banks. These are small banks and operate mainly in the small towns. The banking system in India is primarily modelled on the lines of British banking system and these banks provide mainly short-term finance to the industries. With improvement in financial situation of the country, the banks are showing an increasing interest in providing medium and long term finance to the industries. The share of borrow- ing from banks as percentage of external sources has 34 increased from 35.7% in 1961-62 to 49.5% in 1965-66,11 but most of these finances are in the form of short-term loans which are normally renewed beyond one year. It is grati- fying that under the pressure of industrial demand and better financial situation in the country, the commercial banks are modifying their traditional practices. 3.1.2 Financial Institutions.--Due to the inability of the commercial banks in India to provide long-term loans for industrial financing, a network of financial institu- tions has been developed to fill the gaps in the supply of long-term finance to the industry. These institutions have been set up both by government and private enterprise. These institutions provide long-term finance and other financial facilities to Indian joint stock companies and foreign subsidiaries incorporated in India. The important financial institutions in the field of long-term financing are (1) Industrial Finance Corporation of India, (2) State Finance Corporations, (3) Industrial Credit and Investment Corporation of India, (4) National Industrial Development Corporation, (5) Refinance Corporation for Private Ltd., (6) Unit Trust of India and (7) Industrial Development Bank of India. These institutions were set up after independence. 11Reserve Bank of India, "Finances of Indian Joint Stock Companies, 1965-66," Reserve Bank of India Bulletin. December, 1967, p. 1531. 35 The main purpose of these financial institutions is to provide or guarantee medium and long-term finance for new industrial enterprises and/or for the expansion of existing ones. Besides this, some institutions also underwrite the issue of securities of the companies. These financial institutions have provided finance, not only to the Indian joint stock companies but also to the foreign subsidiaries working in India. Moreover, an amount of finance provided by these financial institutions to the companies has resulted in attracting a much larger volume of finance from the other sources and especially from the international financial agencies. These institutions have, no doubt, contributed the much needed funds to many industries but have been always cautious about the security of their finance and have not taken sufficient risk in providing the finance. This as- pect of the financial institutions has been adequately described by George Rosen. It is important . . . to realize that they are deve1— 0pment institutions, that they exist to take risks which ordinary banks will not take, and that as risk- takers they not only may but also probably will have some losses. Their primary purpose is not security, and they should be relatively free from detailed legislative interference in their Operations so that they will take the risks they are suppose to take.12 12George Rosen, Op. cit., p. 106. 36 3.1.3 Life Insurance Corporation.--The Life In- surance Corporation was set up in 1956 after the national- ization of all the life insurance companies in India. With the increase in the sources of funds of the L.I.C., its in- vestment in the industry is increasing rapidly--and the L.I.C. has emerged as the single largest investor in the corporate sector. Besides its primary investment in the government securities, the L.I.C. invests in the joint stock companies. About 60% of its total industrial hold- ings are concentrated in four industries, i.e., electric power, engineering, cotton textile and iron and steel in- dustries. Moreover, it prefers to invest in the large and well-established industries. The L.I.C. also helps the company by underwriting the shares and securities. 3.1.4 Foreign Sources of Capitall3.—-Besides the various sources of capital in the Indian capital market, there are a number of international sources of capital which are available to foreign investors interested in in- vesting in foreign countries. The international financial institutions such as International Bank for Reconstruction and Development, International Finance Corporation and In- ternational Development Association provide finance to foreign corporations operating in foreign countries and also to the corporations of these countries. 13For a detailed discussion, see Marina Von Neumann Whitman, Government Risk-Sharing in Foreign Investment, (Princeton, New Jersey: Princeton University Press)*l965. 37 The U.S. Government provides finances to the foreign countries either through the U.S. corporations operating in these countries or directly to the public or private enterprises of the foreign countries. These finances are channelled through three U.S. Government agencies: Export-Import Bank of Washington; Agency for International DevelOpment; and Cooley Fund (P.L. 480). Most of the loans made available to the foreign investors by the U.S. lending institutions are provided in dollars and these dollars are generally used for the procurement of raw material, plant and machinery from the U.S.A. In order to meet the local costs of firms in foreign countries, the Congress passed in 1957 the so- called 'Cooley Amendment' to the Agricultural Trade Devel- Opment and Assistance Act of 1954 (P.L. 480). Under the P.L. 480, sales proceeds of the U.S.A. surplus agricultural commodities in the particular foreign country are made available to the private enterprises in the form of local currency loans. These loans are mainly provided to the U.S.A. firms and their branches, subsidiaries or affiliates for business development and trade expansion. The loans are made and repayable in the local currency of the country. The interest rates and the maturity of these loans are similar to that of the country concerned. 3.1.5 Stock Exchanges.--There are eight officially recognized stock exchanges in India located in Bombay, 38 Calcutta, Madras, Ahmedabad, Delhi, Indore, Hyderabad and Banglore. The stock exchanges are regulated under the Securities Contracts (Regulation) Act, 1956. The Bombay Stock Exchange has been granted permanent recognition whereas the other Exchanges get official recognition for a period of five years. The Bombay and Ahmedabad stock exchanges were started before the end of the 19th century and the Calcutta, Indore and Madras exchanges were in existence before the start of World War II. The Delhi and Banglore stock exchanges were set up in 1947 and 1957 respectively. The number of public limited companies listed on the recognized stock exchanges have increased from 1,125 (or 11%) public limited companies in 1948 to 1,547 (or 24% of the total public limited companies) in 1966. In other words, one out of every four public limited companies was listed on the stock exchanges. The large companies are listed on one or more exchanges. Amongst the eight recog- nized stock exchanges, the Bombay, Calcutta and Madras ex— changes are quite big and the listed companies on these three exchanges represent 50% of the total capital of all the public limited companies in India. There has been significant change in the pattern of the ownership of corporate shares during the period 1959 and 1965. The ownership of shares by the financial institutions has increased in 1965 as compared to the year u" n.- 0" Q;- '1' (ID ll) 39 1959, As against this, the individual ownership has de- 14 This change is mainly due clined during this period. to the steps taken by the government to strengthen the institutional investors in the capital market by setting up of the Industrial Finance Corporation, State Finance Corporations, Unit Trust of India, Industrial Development Bank of India, etc. Moreover, the setting up of Life In- surance Corporation by nationalizing the life insurance companies has emerged as the single largest financial in- vestor in the Indian capital market. 3.1.6 Managing Agency System.--The managing agency system was introduced by British investors to manage their subsidiaries in India after the termination of the East India Company's monOpoly trade with India. Due to the lack of sufficient number of managerial personnel, British companies established agency houses to manage a group of concerns on their behalf. Later on the Indian firms also adOpted the managing agency system. Under this system, an individual, a partnership firm or a body corporate under- takes to manage another company. With the passage of time, the managing agencies began to represent more than one principal and acted in many capacities such as promoters, issue houses, underwriters, and bankers for the managed 14Reserve Bank of India, "Survey of Ownership of Shares in Joint Stock Companies at the end of December, 1965," :Reserve Bank of India Bulletin, February, 1968, p. 145. all .t .1 VI 0! 4!: in .‘ '- n.- V‘ a. Vs 'u n; W‘ 40 companies. They also stood guarantor to the other finan- cial institutions and financiers. These managing agencies had been very influential in shaping the develOpment of many industries. Because of their managerial skill and strong financial position, they influenced the Indian capital market. The main con- tributions of the managing agencies in India may be des- cribed as the initiation and promotion of many new indus- tries; providing financial resources to the managed companies and other companies; managing the company's affairs as a professional executives; and standing as guarantor to the outsiders for obtaining finance for the company. Besides their contribution to the development of many industries in India, the managing agency system is also responsible for many malpractices introduced in the management of the companies. They charged high remunera- tion and office allowance fees for their services and high commission on sales and purchases; invested the managed company's funds for speculative purposes; paid insufficient attention to the right of shareholders; and concentrated the managerial power in their hands. To minimize these defects, the government introduced strict regulations from time to time, on their appointment and tenure, their re- muneration, their power of management, etc. 41 PART I I Government Policies and Regulations Affecting Foreign Investment The Government of India has formulated various policies and regulations affecting the Operation of enter- prises including foreign private enterprises in India. The policies describe the general framework of industries, nature of foreign ownership, possibility of remittance of profit, tax incentives, import and exports of goods, etc. The government also uses many regulatory measures such as industrial licensing, foreign exchange control, new capi- tal issues, etc. to influence the activities of the foreign private enterprises. (1) Industrial Development Policy The industrial policy of the country is based on the Industrial Policy Resolution of 1948 which was later modified in April, 1956 at the start of the Second Five- Year Plan. The Industrial Policy Resolution of 1956 classifies all the industries into three categories. The first category includes arms and ammunition, atomic energy, iron and steel, heavy engineering and heavy electrical plants, coal, oil, most mining, aircraft, air tran5port, railways, ship building, communication, and electrical generation and distribution. The public sector will have the exclusive responsibility for their future 42 develOpment. The existing private sector in these indus- tries is permitted to continue and may be allowed to expand if considered necessary in the national interest of the country. The second category includes some mining, aluminum, machine tool, ferrous alloys and tool steels, heavy chemi- cals, essential drugs, fertilizer, synthetic rubber, and road and sea transport. These industries will be progres- sively state-owned and in which the state will generally take the initiative in establishing new undertaking but in which private sector is also expected to supplement the effort of the state. The third category includes all the residual in- dustries whose future development will, in general, be left to the initiative and enterprise of the private sector. The above classification of the industries should not give the impression that there is a clear-cut demarca- tion for the setting up industry by public and private sectors. The above division is of general nature and there is no rigid policy for their execution. The fact is, however, that the rigid categories and austere phrases of the Industrial Policy Resolution of 1956 in no sense adequately indicate the present disposition of the Indian government toward organized private enterprise. In practice the sc0pe for private expansion is subject to compromise. 15John P. Lewis, op. cit., p. 223. 43 The economic needs, foreign exchange shortage and national interest of the country have influenced the industrial policies in practice. It is rather difficult but not impossible to get permission for the establishment and expansion of private enterprise in the first category. The government has al- ready given permission for the expansion of the two private steel companies. Moreover, the government has also allowed foreign collaboration for Oil refineries and heavy electri- cal equipments falling in the first category considered to be necessary in the national interest of the country. In the second category also, there are many cases where the government has allowed the private sector to set up indus- tries such as synthetic rubber, fertilizer, aluminum, etc., with foreign collaboration. The government has followed a pragmatic approach toward the setting up of industries in the private sector. It has augmented credit facilities to the private sector and has allowed the private sector to Operate their business without much control and has a fine reputation of not nationalizing the private sector enterprises. (2) Foreign Investment Policy After the attainment of political independence in 1947, the Government of India realized the greater need for the foreign capital. The need was expressed from time to 44 time in the various statements. The industrial policy statement of 1948 incorporated some of these expressions but the major policy regarding the foreign investment was expressed by the then Prime Minister of the country in his statement on foreign capital to the Indian Parliament on April 6, 1949. This statement proved to be the back- bone of India's foreign investment policy. The statement points out the six important elements of this policy. (1) There would be no discrimination in the treat- ment of domestic and foreign enterprises and all would have to conform to the industrial policy Of the country. (2) Foreign enterprise would be permitted to earn profits subject only to regulations common to all. (3) There would be no restriction on the remittance of profit or repatriation of capital but remit- tance facilities would naturally depend on the foreign exchange situation. (4) If the foreign interests come to be compulsorily acquired, compensation will be paid on a fair equitable basis and reasonable facilities will be provided for the remittance of the proceeds. (5) The major interest in ownership and effective control Of an industrial undertaking should, as a rule, be in Indian hands. (6) Indians should be trained and employed in mana- gerial and technical posts as quickly as possible. On the basis of the above statement, the Govern- ment of India deve10ped the various qualifications for the acceptance or rejection of the foreign investment projects. These qualifications have been mentioned in different docu- ments and statements and have not been incorporated in any 45 single document which may be cited as the official docu- ment on the foreign investment policy of the Government of India. The specific qualifications for the acceptance of the foreign investment projects are that the foreign in- vestment projects must set up manufacturing units in India; their products should be considered important for the economy of the country; and the project should be able to produce such goods which either act as import substitution or encourage export and thereby should be able to meet the foreign exchange requirements of the country. Thus India seeks foreign investment especially in those areas which would help speed the attainment of the Five-Year Plan tar- gets and which at the same time would not impose undue strains on the country's foreign exchange reserve. When the foreign investment agrees to the above broad qualifications, the negotiations between the differ- ent groups are carried out, and plans are submitted to the Government of India for the final approval. The government has developed a long procedure for the scrutinizing and screening of these foreign investment projects. It has been particular regarding the manufacturing scheme Of the foreign investment projects and in many cases foreign firms with modest manufacturing scheme have not been permitted to set up the project. 46 Since the beginning of the Second Plan, the Govern- ment of India encouraged joint ventures between the foreign and the Indian firms and insisted that the foreign collabo- ration should cover all the foreign exchange costs of the project. The main reason behind this attitude was to put less strain on the already adverse balance of payment posi- tion. The foreign joint ventures were also attractive to the Indian partners who cannot start the new industry re- quiring foreign plant and machinery without approaching the government for the release of foreign exchange. The best and only alternative to them was to collaborate with the foreign enterprise and meet the requirement of imported plant and machinery. Moreover, the foreign firms also prefer to collaborate with the Indian firms so as to meet the various local requirements better known to the local firms. Thus the economic need of country, acute shortage Of foreign exchange, adverse historical experience with the British foreign investment and the nationalistic atti- tude Of the political parties have greatly influenced the foreign investment policy of the country in the initial period of its economic development. However, the initial good experience of working with many foreign investors, favorable impact of foreign private investment on the econo- my, receptive attitude of the government and the greater need for the foreign capital in some industries encouraged 47 the Government of India to take some encouraging steps towards liberalization of the foreign investment policy. A significant step was to allow majority ownership in some industries and to relax the import controls for the import of components, spare parts and raw materials for tOp priority industries. (3) Corporate Taxation Policy Taxation policy may be considered as an important factor in attracting foreign investment. There are dif- ferent views on this subject. Some experts feel that tax incentives are of paramount importance for foreign inves— torsl6 while others think that taxation does not affect 17 It is beyond the their foreign investment decision. sc0pe of the present research to examine and evaluate this controversy. In this part, only those aSpects of Indian corporate taxation have been discussed which affect foreign subsidiaries. 16Anant R. Negandhi, Private Foreign Investment Climate in India, (Graduate School of Business Administra- tion, Michigan State University, East Lansing, Michigan, 1965) PP. 69-71. 17Judd Polk and others, U.S. Production Abroad and the Balance of Payments, (New York: National Industfial Conference Board771nc., 1966) p. 51; E. R. Barlow and Ira T. Wender, United States Tax Incentives to Direct Private Foreign Investment, (Cambridge, Mass: Harvard Law SCHOOI, 1954) p. 4. 48 3.1 Tax Liability of Joint Venture Companies18 The tax liability of a company depends upon whether it is a domestic company or a foreign company; whether it is a widely-held company or a closely-held company; and whether it is an industrial company or a trading or ser- vice industry. A domestic company, under the Income Tax Act has been defined as a company which has made arrange— ment for the declaration and payment of dividends within India. Thus if a foreign subsidiary is incorporated in India and declares and pays dividends in India, it is treated as a domestic company for the purpose of Indian taxation. A foreign company is one which does not declare and make payment of dividends in India. The latest rates of income tax on companies in respect of income other than capital gains are as follows: Rate of Tax 1. Domestic company in which public are substantially interested (i.e., widely-held corporation including the wholly-owned subsidiaries of such company) (a) if the total income does not exceed Rs. 50,000 . . . . . . . . 45% of the total income (b) if the total income exceeds RS. 50,000 0 O O I O O I O O O O 55% Of the total income 18It is based on Indian Investment Centre, Taxes and Incentives, (Delhi: Indian Investment Centre, June, 71968). 49 Rate of Tax 2. Foreign companies which have not made prescribed arrangements for declaration and payment of divi- dends within India (a) on the income consisting of royalties and technical services fees received for an Indian con- cern, where such agreement has been approved by the Government . 50% of the total income (b) on any other income included in the total income . . . . . . . 70% of the total income 3.2 Surtax on Company Under the provisions Of the Companies (Profit) Surtax Act 1964, a company pays surtax on its 'chargeable profits.‘ The surtax rate on its 'chargeable profits' is 35% of the profits exceeding Rs. 200,000 or a sum equal to 10% of its capital (as determined under the provision Of the Surtax Act) whichever is greater. The income of non-resident corporate investors de- rived from dividend, interest on loans, royalties and technical fees are not included in 'chargeable profits' and hence are exempted from surtax. Therefore, the inci- dence of surtax on foreign corporations are negligible. 3.3 Tax on Capital Gains NO capital gains tax is levied on the transfer of short-term capital assets because such income is treated as ordinary income. The transfer of capital assets other 50 than the short-term assets are treated as capital gains. There are two rates. The capital gains derived from the sales of buildings or land or any rights in the buildings or land are taxed at the rate of 40% whereas in the case of other capital gains the rate is 30%. 3.4 Tax on Intercorporate Dividends The parent company and its subsidiaries are treated as separate entities under the Income Tax Act. When a parent company receives dividend from its subsidiaries, it has to pay tax on such dividends. But the tax rate is lower than on any other type of income. If the foreign investor is a company, the effective rate is 24.5% of the dividends received from a domestic company. 3.5 Statutory Ceiling on Corporate Taxes Recently the Government of India has introduced a statutory ceiling on corporate taxes. According to this ceiling, the total tax liability (income tax plus surtax) should not exceed 70% of the total income of a widely-held domestic company whose paid-up equity capital is not less than 25% of the amount of its capital (including reserve) as ascertained for the purpose of surtax. Any excess liability over the 70% is allowed as a reduction in surtax payable by the company. 51 3.6 Special Tax Incentives Even though the Government of India has introduced a statutory ceiling on the tax rates, the effective rate of tax on corporation is lower than the actual tax rates mentioned above. This is mainly due to the various tax incentives and tax credit certificates provided under the Indian tax system. For instance, domestic companies en- gaged in 'priority' industries are allowed a deduction of a sum equal to 8% of the profits for tax purposes. A special deduction for development rebate is allowed which may be up to 30% of the cost of new plant and machinery for 'priority' industries. The new industrial firms get a tax holiday benefits for five years up to 6% of the capital employed. There are a number of other deductions such as additional depreciation allowance for extra shift work, capital expenditure on scientific research, etc. There are as many as 28 tax incentives. Besides these tax incentives, there are other tax benefits in the form of tax credit certificates granted to the taxpayers for their performance in the field of production.19 The overall impact of these tax incentives and taX credit certificates is to minimize the tax burden on the investors. In the first five years of its working, the effective tax rate in the case of such new industrial company (widely-held 19Taxes and Incentives, Op. cit., pp. 49—54. 52 domestic industrial company engaged in priority industry) may vary from 37.82 to 40.06% inclusive of income tax, surtax and dividend tax.20 (4) Import and Export Policy 4.1 Import Policy The shortage of foreign exchange and the greater need for the import of raw materials, plant and equipment from foreign countries for the rapid industrialization of the country necessitated the Government of India to allo- cate the foreign exchange in the best possible manner. To meet this situation, the government followed a restrictive import policy and granted quotas to the established import— ers for the imports of items of special importance for the economy or items which had an export promotion angle. Thus the main emphasis had been to keep down im- ports to a minimum possible extent. No import license was given if there was adequate production of the same or similar goods in India. Moreover, the government always encouraged the importers of the goods to make arrangements for providing foreign exchange either through investment from overseas in the form of equity or import of plant and machinery or long-term loans in foreign currency. In many 20Indian Investment Center, Whinnvest in India? (New Delhi: Indian Investment Centre, March 1967) p. 21. 53 cases, the machinery and equipment were supplied by the foreign collaborators in exchange of equity shares. In 1965, the Government of India adopted an extra- ordinarily strict import licensing program. This was partly due to the greater need for import of foodgrain to meet the drought situation of the country and partly due to the delays in securing foreign aid from the foreign countries. As a result of this policy, there were acute shortage of imported raw materials and components for many industries which were compelled to operate below their capacity. In 1966, the Government of India liberalized the import restrictions. Under the liberalized import policy (1) 59 specific priority industries are allowed to import the raw materials, components and spare parts necessary to maintain production at full capacity; (2) raw material requirements of certain export industries have been placed on Open general license; (3) the value of import license Of established importers has been increased for specified essential commodities; and (4) actual users and traders are being granted licenses freely for importation from the U.S. against U.S. AID non-project loans of certain Spare parts not produced in India. Thus under the liberal import policy, the producers have to decide the total quantity of materials to be imported and there is no absolute ban on the import of goods which are produced in India. yo: -\ 54 4.2 Export Duty In order to augment the foreign exchange reserve, the government had always emphasized the increase in the export Of goods from India. The government adopted a sys- tem of issuing import entitlement licenses as an incentive to exporters of the non-traditional items. Under this scheme, the exporters were given license equivalent to twice the import content of their exports. Moreover, the government introduced better coordination between import and export policies and more vigorous drive to boost ex- ports. Various promotional measures were adopted so that the Indian exporters may be able to compete in the inter- national market. DeSpite these measures, the export of the country could not increase substantially. To meet this situation, the Government Of India decided to devalue the Indian cur- rency on June 6, 1966. The Old import entitlement scheme was abolished and the government decided for the first time to issue direct import license to export houses on the basis of their export performance. Free foreign exchange is being reserved for those industrial units which have exported 10% or more of their product so that they are allowed preferred sources of supply and facilities for expansion. It is very hard to judge the impact of devaluation and liberalized import and export policy on the Indian i 55 economy but it can be said that they have greatly improved the structure of prices and incentives and should contri- bute importantly to raising industrial efficiency and production.21 (5) Industrial Licensing The Industries (Development and Regulation) Act 1951 controls the establishment and expansion Of indus- tries by requiring the undertaking to take registration for every existing industrial unit and a license for the setting up of new firms. Foreign subsidiaries are also required to comply with the same provision. The Act is designed to facilitate economic development through a planned economy under a democracy. The main purpose of issuing the industrial registration and the licensing is to regulate establishment and expansion of different in- dustries in the country with a View to utilizing the limited resources and foreign exchange of the country for rapid industrialization. The Act gives the Government of India broad powers over the registered and licensed industrial undertakings to make investigation into their operations and issue direction for change; assume management and 21Kenneth M. Kauffman,"The Indian Economy: Some Recent History and Near Term Prospectsf'Asian Survey, June 1967, Vol. VII, No. 6, p. 422. 56 control of the industry; and control the supply, distri- bution and prices of their production.22 Government follows different policies of indus- trial licensing depending upon the nature and importance of the industries. The key industries such as pig iron, industrial machinery, machine tools, fertilizers, petro- chemical, paper and pulp, cement, etc., considered to be important for the promotion of self-sustaining industrial growth are given preferential treatment in respect of re- lease of foreign exchange and for all other clearances such as permission for the issue of new capital, import of capital goods from the foreign country, etc. Certain in- dustries considered to be important but not requiring sub- stantial import of components or raw materials from foreign countries have been exempted from registration and licens- ing provisions of the Act. (6) Foreign Exchange Control The Government Of India and the Reserve Bank of India under the Foreign Exchange Regulation Act, 1947, control the prOper utilization of foreign exchange reserve. No person is allowed to make payment to persons resident outside India without the permission of the Reserve Bank. 22For details, see Matthew J. Kust, Foreign Enter- prise in India--Laws and Policies, (Chapel Hill: The Uni- versity of North Carolina Press) 1964, esp. Chapter VI. 57 The remittance of profits and other income (such as royalties, patent fees, commissions, etc.) to a foreign country is permitted without any restriction provided the prior permission of the Reserve Bank of India has been ob— tained. When the government issues an industrial license for the Operation of foreign enterprises it also authorizes them to convert the profit, original investment, loan, etc., from the Indian currency into the currency of foreign countries. The historical evidence shows that the permis- sion for the remittance of profit has been granted without any difficulty. "Few countries in the world have maintained a record of prompt remittance that compares with India's despite the extreme shortage of foreign exchange that has faced the country during the past five years."23 The repatriation of original capital plus all re— invested profit and capital appreciation requires the prior approval of the Government of India. Prior to the year 1958, there was no restriction on the remittance of capi- tal from India. In 1958, the government introduced certain restrictions regarding the period when the capital can be remitted. For this purpose the government insists that the prospective investors should not repatriate their capital 23India: Business International Indian Roundtable, (New York: Business International Corporation, 1961) p. 17. (Quoted in Anant R. Negandhi, Private Foreign Investment (llimate in India, (East Lansing: Graduate School of Busi- ruess Administration, Michigan State University, 1965) p. 72. 58 for 10 years or so. This restriction is placed primarily to discourage the heavy drains on the foreign exchange reserve of the country. If the government thinks proper, the time limit may be relaxed. Besides the freedom of remittance of profit and capital, the Government of India maintains a stable rate Of exchange for all international transactions. The foreign exchange is obtained at the official exchange rate. Multi- ple rates have never been used in India. Indian currency was never devalued between 1949 and 1965 and hence a stable exchange rate was maintained throughout this period. On June 6, 1966 the Government of India devalued the Indian currency and this changed the previous exchange rate. Since then, the new exchange rate is also kept stable. The above description indicates that India Offers complete freedom of profits and repatria- tion of capital and maintains stable exchange rate. All profits and dividends have always been fully convertible into the currency of the country of the original investor. And convertibility is not limited to earnings only; it applies to capital and indeed to capital appreciation. This policy had not altered ever since exchange control was instituted in India more than 20 years agozznd India has no intention of altering it in future. 6.1 U.S. Guarantee Program The security of investment of foreign investors is forizified by the bilateral agreements between the Government 24Indian Investment Centre, Why Invest in India, 02. Cite, pp. 7-8. wa .5; .0 2w: (‘ nus: \‘ ROI» V b-Aer Ar 1 575. w. :0 .t- o.‘ v»: ,- U'l A v \I s . Q. p: . V 59 of India and Governments of foreign countries. The U.S. Government Offers a range of investment guarantees for U.S. private investment in India. These are: (1) The Specific Risk Guarantee: the private investment is guaran- teed against inconvertibility and losses through expropria- tion, confiscation, war, revolution or insurrection, for new American investments of cash, commodities, patents or services made by the U.S. individuals or firms in India; and (2) The Extended Risk Guarantee coveres business risks other than those resulting from fraud or misrepresentation or misconduct of investor and those for which commercial insurance is available, such as fire and insurance. The Extended Risk Guarantees cover up to 75% of investment funds extended by American lenders and generally up to 50% Of U.S. equity contributions. (7) Capital Issue Control The capital issue control was first introduced, to meet the situation arisen due to World War II, under the Defense of India Act (1939) and was replaced on a tem- porary basis by Capital Issue (Continuance of Control) Act of 1947 and then was made permanent in 1956 as Capital Issue (Control) Act, 1957. The main purposes of the Act are (l) to insure that the investment does not take place cxnrtrary to the Objectives of the Five-Year Plans or flow intx> unproductive or wasteful channels; (2) to further the ~- ‘. ob ‘v iv. . \ V F! 60 growth of joint stock companies with sound capital struc— ture and promote a rational and healthy expansion of joint stock sector in the general interest; and (3) to direct and distribute appeals for public subscription to new issues for capital so as to avoid any undue concentration or over- crowding in a particular period or part of the year. The above objectives indicate that the Act is the most effective regulatory measure in the hands of the government. It influences not only the investment policy of the individual company but is a strong measure to regu- late the nature and the different mix of the capital structure. This Act also tries to minimize the heavy load of the capital issue in a particular season and thereby tries to eliminate the season fluctuations in the avail- ability Of the new issues in the capital market. The capital issue control applies generally to all companies which make an issue of capital or make an Offer to sell securities in India. Moreover,the Act has the effect of forcing companies to raise enough long—term capi- tal to finance their establishment or major expension, rather than relying on loans from uncertain sources or depending vaguely on self-financing from large future profits. 7.1 Capital Structure The Act is quite Specific in prescribing the ratios Of debt-equity and preference—equity in the capital structure Q 9‘ 9‘ ~ A but: M" bull r‘ t“ H‘\ VII (D (I) fl: (I) .i .‘V [1! 1 61 of the companies. According to the Act, the most suitable debt-equity ratio is the 2:1, but this ratio may be in- creased in the case of some companies. For the companies in the public sector, the government prefers equal debt- equity ratio. In the case of preferred stock-common stock ratio the Act prescribes that preference shares (stated capital) should not exceed one-third of the common stock equity. Like the debt—equity ratio, this ratio may, under some circumstances, go up to 2:3. The above restrictions regarding the ratios are based on the notion that excessive leverage is seldom in the best interest of the company (and the economy) from long-term viewpoint. Thus the in- dividual company is not free to have just any capital structure which the management may desire nor to adjust the capital structure without the prior approval of the Controller of Capital Issues. If a company wants to adopt a different capital structure it has to seek the approval of the Controller of Capital Issues. Summary To sum up, the chief features of the Indian econ- omy during this period were the stagnation in agricultural and industrial production, deficit balance of payments and rapid expansion in the money supply to meet the needs of defense and development expenditure. The over-all effect of these factors was the strong pressure on the price 'wel .vl O 790* and b' on» v ‘;“Y aulvo . . 'HO‘A ¢¢b&\ EAAy-(p brink An4‘. .- Vat-econ - . H‘V bu _ _A. 1' J 62 level. The difficulty in raising resources for invest- ment, the sharp decline in foreign exchange reserve of the country, and the postponement of foreign aid by some major countries aggravated the already deteriorating con- dition of the economy. By the end of 1965, the Indian economy was undergoing the acute shortage of foreign ex- change and many industries were operating below capacity due to inability to import components and raw materials on the one hand and the decreased in the agricultural out- puts for the agro-based industries on the other. The 1963-1967 period also encompassed political developments. The country had a strong and stable govern- ment at the national and state levels prior to the fourth general election in 1967. Then the politically dominating and ruling Congress Party, suffered an unprecedented set- back in the fourth election, its majority was significantly reduced at the national level, and in many states it could not form the government. Moreover, in two states, the Com- munist Party along with other parties formed governments. The thin majority of the ruling party in the Indian parlia- ment and the absence of a strong Opposition party in the country results in less political stability. Despite political instability, there remain certain inherent and orderly factors in the Indian democracy which may continue to provide basic strength to it. 63 The increasing emphasis on the industrialization of the country has resulted in greater need for adequate funds to meet the financial requirement of industry. The features of the Indian capital market have undergone sig- nificant changes to meet the challenge of the situatiOn. To facilitate economic development through a planned‘ economy under a democracy, the Government of India has for- mulated various policies such as industrial development policy, foreign investment policy, corporate taxation pol- icy, import and export policy, etc. The Government has many regulatory measures such as industrial licensing, foreign exchange control, new capital issues, etc. to in- fluence the activities of the foreign investment in India. These environmental factors, then, form part of the background for understanding and evaluating the data developed in the Chapters V and VI. CHAPTER III DATA COLLECTION The present chapter describes the data collection for this study. The information has been collected from three sources, i.e., annual reports of U.S. subsidiaries, a questionnaire survey and personal interviews. The first part of the chapter discusses the nature of population and subsidiaries included. It describes, in detail, size, in- dustrial products, age composition, management, and owner- ship of the participating subsidiaries. These data are used in analyzing the investment policy and performance of the participating subsidiaries discussed in Chapters V and VI. A discussion of the representativeness of the partici- pating subsidiaries in the total population is also included. The second section explains the nature and purpose of the questionnaire survey, and emphasizes the relevance of such data for the present study. The last part describes the personal interviews with executives of several parent corporations having equityinvestment in India. PART I To examine and evaluate the investment policy and performance of the U.S. subsidiaries working in India, the 64 9: 65 annual reports of the subsidiaries were used as the pri- mary source of information. The financial data about the parent corporations were collected from the Moody's Indus- trial Manual for the different years. Selection of Population To define the type of subsidiary to be included in the present study, the following criteria were adapted. 1. The U.S. subsidiaries in India should have either equity investment or equity/licensing investment from the U.S. Corporations. The U.S. subsidiaries having only licensing agreements or selling and service arrangements with the parent corporations should not be included in the present study, nor should affiliates with less than 10% American equity investment. The U.S. subsidiaries should have been in existence in India prior to the year 1963, must have started production before 1965, and must have continued their operation in India during the period 1963 to 1967. The U.S. subsidiary operating in India should be a widely-held corporation (known as "public limited company" in India) so that its annual reports may be available to the outsider. In other words, the closely-held U.S. subsidiaries (known as "private 66 l in India) or branch units of the limited company" U.S. corporations in India should not be included because they do not publish their annual reports. On the basis of the above criteria, an attempt was made to identify all Indian companies with U.S. equity in- vestment.2 Since it was not possible to determine which of those listed were merely branch units nor percentage of equity investment nor continuation and discontinuation of 1The private limited company is more or less family concerns. The minimum number of membership for such a company is two and the minimum number of directors is two and its articles of association which must be registered with the Registrar of Companies, must contain the follow- ing distinguishing features: (a) a clause restricting the right to transfer its share; (b) a clause limiting the number of its members to fifty, two or more persons holding shares jointly being counted as a single member; and (c) a clause prohibiting any invitation by the company to the public to subscribe for any shares or debentures of the company. A public limited company is one which is not a private limited company. The minimum number of members for such a company is seven and the minimum number of di- rectors is three. The Indian Companies Act does not lay down any maximum limit to the number of directors either for a public limited company or for a private limited com- pany. (Indian Investment Centre, Indian Company Law, (New Delhi:Indian Investment Centre) 1967, pp. 14-16. 2The details were obtained from a booklet entitled Inherican Business Concerns, Educational and Philanthropic Institutions with Offices in India, published by U.S. Em- Bassy in India, December, 1965. .r‘ .ovI nI-v. V'.' r'”: DOV- .—n on» ._ .‘fl 5" KL) ‘1 "v - flu. .. -., '11 I7 \. 67 these subsidiaries, it was decided to contact parent cor— porations and hence a letter was sent to all U.S. corpora- tions requesting them to participate in the present study. The response of the U.S. corporations enabled the identi- fication of the branch units (14), the U.S. corporation's equity investment with less than 10% in Indian companies (9) and the discontinuation of some subsidiaries (15). Moreover, an intensive search of other sources was also conducted to determine these cases. Thus there were 42 U.S. subsidiaries constituting the total population, based on the above criteria, for the present study. A check was made to verify the availability of financial data of the U.S. corporations in Moody's In- dustrial Manual for the different years. Financial data about five U.S. corporations were not available. These corporations were asked to send their annual reports but refused to do so because they are closely-held corporations and are not listed on the stock exchange. This left 37 U.S. subsidiaries (and their parents) as the total pOpula- tion for the study. The details are given in Table 3:1. Out of 37 parent corporations having direct private investment in India, 28 parent corporations (or 75% of the total) are among the "500" largest U.S. industrial 3Moody's Industrial Manuals (New York: Moody's Investors Service, Inc.);unsiness International (New York: Business International Corporation); Indian Stock Exchanges (Bombay, Calcutta and Madras) Year Books, Indian Financial Newspapers , etc . l) oi‘i‘ h) ' ul‘ (‘N “v- .. . 1‘ . "0 (D 68 Table 3:l.--Selection of population for the present study. Number 1. Total U.S. Subsidiaries selected on the basis of criteria . . . . . . . . . . . . . . . 80 2. Total U.S. Affiliates decided on the basis of response (a) U.S. Branch Units . . . . . . . . . . 14 (b) U.S. Affiliates with Minor Investment . . . . . . . . . . . . 9 (c) U.S. Subsidiaries that could not start their Operationa. . . . . . . 15 38 3. Total U.S. Subsidiaries eligible for the present study . . . . . . . . . . . . . . . . . 42 4. Less:closely-held parent corporations . . . . . . 5 5. U.S. Subsidiaries as total population . . . . . . 37 6. U.S. Subsidiaries for which financial data became available . . . . . . . . . . . . . . . 27 aThis group includes subsidiaries which could not proceed beyond negotiation stage or closed their initial Operation. corporations. Out of 27 parent corporations whose subsidiaries in India have been taken up for the present study, 23 U.S. corporations (or 85% of the total) are among the "500" larg- est U.S. industrial corporations. This suggests that Ameri- <:an equity investment in India comes largely from larger [1.8. corporations.4 4The Fortune Directory, The '500' largest U.S. In- chistrial Corporations, June 15, 1968. 69 Selection of Subsidiaries Some U.S. corporations sent annual reports of their subsidiaries while many of them wrote directly to their subsidiaries in India to send the annual reports. Some of these subsidiaries responded favorably and supplied their annual reports. In the remaining cases, individual letters were sent to the U.S. subsidiaries in India. A follow-up letter was necessary in several cases where the: initial letter was not acknowledged. Moreover, some finan- cial data about these subsidiaries were also collected from Indian financial newspapers,;Investor's India Year Book, Indian stock exchange year books, etc., available at the Michigan State University, University of Michigan and Uni- versity of Chicago libraries. Out of 37 U.S. subsidiaries, the annual reports of 27 U.S. subsidiaries were made available for the years 1963 to 1967. Out of these, 25 U.S. subsidiaries are en- gaged in manufacturing Operation and the 2 U.S. subsidiaries are in the petroleum industry. Thus the participating sub- sidiaries form 73% of the total U.S. subsidiaries eligible for the present study. The reason for non-participation may vary greatly. In some cases, the non-participation resulted due to the refusal to take part in the study for the reasons of com- pany policy. In a few cases there might have been a desire to avoid publicizing the results of a very profitable l'i' (I) Anti - (I) '1‘] J. l I. 'fl O.‘ Q; J 4 -v n-‘ . H;. .1.‘ flu. ”in l (U I! 7‘ I 7O operation but in some others the motive might well have been a desire to conceal an unsuccessful Operation. It is hard to determine the nature of systematic bias, if any, in the study due to the non-participating of the 10 U.S. subsidiaries. Size of Participating Subsidiaries in Manufacturing Industry Of the total paid-up capital of Rs. 426.69 million of the U.S. subsidiaries comprising the total population, the participating subsidiaries contributed Rs. 383.14 mil- lion (Or 89.79% of the total) in 1963. In the case of net worth, the participating subsidiaries provided Rs. 441558 million out of Rs. 480.96 million (or 91.8% of the total) net worth of the total U.S. subsidiaries. The contribution of the participating subsidiaries in the total assets of all U.S. subsidiaries is 95.57% (or Rs. 1072.41 million out of a total assets of Rs. 1122.08 million). The partici- pating subsidiaries shared 98.35% (or Rs. 656.89 million out of Rs. 667.89 million) of the total sales of all U.S. subsidiaries in 1963. Thus the participating subsidiaries contributed at least about 90% of the total assets, sales, net worth and paid-up capital of the total population. Table 3:2 shows this picture. 71 Table 3:2.--Size of population and participating subsidi- aries in manufacturing industry in 1963 (in millions of rupees). Total U.S. ' ‘Participating Subsidiaries* Subsidiaries' (N = 31) (N = 25) Percentage Rs. Rs. of Total 1. Assets 1,122.08 1,072.41 95.57 2. Sales 667.89 656.89 98.35 3. Net Worth 480.96 441.58 91.8 4. Paid-up Capital 426.69 383.14 89.79 Source: (1) Annual Reports of Participating Subsidiaries; (2) Indian Stock Exchanges (Bombay, Calcutta and Madras) Year Books; (3) Investors' India Year Book (Calcutta: Orient Longmans, Ltd.) . _ . *Figures for the remaining 3 manufacturing industries not available. Size of Partigipating Subsidiaries in Petroleum Industry: Out of the total U.S. subsidiaries in petroleum industry, the participating subsidiaries contributed 50.35% (or Rs. 45.63 million out of Rs. 90.63 million), 61.04% (or Rs. 273.39 million out of Rs. 447.89 million), land 94.21% (or Rs. 427.92 million out of Rs. 454.22 mil- lion) of the total paid-up capital, total assets and total sales of the U.S. subsidiaries engaged in petroleum in- dustry in 1963. Table 3:3 gives this picture. 72 Table 3:3.--Size of population and participating subsidi- aries in petroleum industry in 1963 (in millions of rupees). Total U.S. Participating Subsidiaries Subsidiaries (N = 31) (N = 25) Percentage Rs. Rs. of Total 1. Assets 447.89 273.39 61.04 2. Sales 454.22 427.92 94.21 3. Paid-up Capital 90.63 45.63 50.34 Sources: Same as Table 3:2. Products of Participating Subsidiaries The major product groups of 25 manufacturing sub- sidiaries represent chemicals, electric equipment, rubber and plastic, machinery, metal and metal products and transport equipment. The distribution of total and par- ticipating subsidiaries in different industrial groups is shown in Table 3:4. Thus in each product group the participating subsidiaries are at least 50% (except in electrical goods) of the total population and not a single industrial product group is excluded from the present study. Many of the subsidiaries have Operations which fall under more than one industry classification and do not present any basis for distinguishing their industry lines 73 Table 3:4.--Distribution by major product group of total and participating subsidiaries. Total Participating Subsidiaries Subsidiaries Product Group Percentage Percentage Number of Total Number of Total Manufacturing 1. Transport Equipment 6 16.2 4 14.9 2. Machinery Equipment 7 18.9 5 18.5 3. Metal and Metal 3 8.2 3 11.1 Products 4. Electrical Goods 4 10.8 1 3.7 5. Chemicals and Allied 7 18.9 5 18.5 6. Others 7 18.9 7 25.9 Petroleum _3 8.2 _2 7.4 Total 37 100.0 27 100.0 of operation clearly. This problem of separating the in- dustrial lines in a company's operation seems to be common in view of company growth and diversification. Despite these difficulties and limitations, the broad classifica— tion may be made for the present study. The subsidiaries of U.S. corporations in India are engaged in the production of many goods in which the parent corporations have specialized. The main products of the parent corporations are identified on the basis of the Moody's Industrial Classification. This broad classification 74 was verified with the categories of the Operations of the parent corporations as given in the U.S. Embassy's Book— let.6 These groupings were quite similar. After this, the industrial products of each participating U.S. sub- sidiaries working in India were identified with the help Of the information available in annual reports of these subsidiaries, Indian Stock Exchange Year Books, Investor's India Year Book, Indian financial newspapers, etc. These subsidiaries are producing the same general types of prod- ucts as their parent corporations. These subsidiaries do not normally produce a single product and are of diversi- fied nature. Incgption Dates of Participating Subsidiaries The dates of inception of 27 participating sub- sidiaries varied widely (see Table 3:5). Five of the 27 subsidiaries were set up prior to 1950 and another five subsidiaries were started between 1951 and 1956. Thus about a third of the total participating subsidiaries had at least seven years' working experience prior to the year 1963. One subsidiary was started as early as 1922. Be- tween 1957 and 1961, twelve more subsidiaries were set up. The remaining five subsidiaries were started in 1962. Thus 6See Footnote 2 on page 66. 75 there are both mature and new subsidiaries among the par- ticipating subsidiaries. Table 3:5.--Distribution by date of inception of 27 par- ticipating subsidiaries. Participating Subsidiaries Year Percentage Number of Total Prior to 1950 5 18.5 1951 to 1956 5 18.5 1957 to 1961 12 44.4 1962 _§_ 18.5 Total 27 100.0 Ownership Pattern of Participating Subsidiaries The ownership pattern of 27 participating subsidi- aries is given in Table 3:6. Ten of the participating subsidiaries have majority ownership, i.e., the U.S. equity investment is more than 50% of the total equity investment. As against this, the U.S. investment in eight of the par- ticipating subsidiaries is between 10% and 25%. Between the above two groups, there are five subsidiaries where the U.S. ownership is between 26% and 40% and four where the ownership is between 41% and 50%. 76 Table 3:6.--Distribution by ownership pattern of 27 par- ticipating subsidiaries. Participating Subsidiaries Percentage of American Ownership Numb Percentage er of Total Between 10 to 25 8 29.6 " 26 to 40 5 18.5 " 41 to 50 4 14.8 " 51 to 75 6 22.3 76 and Above _4 14.8 Total 21 $2212 Management of Participating Subsidiaries The nature of management of participating subsidi- aries is given in Table 3:7. Out of the total participating subsidiaries, 3 subsidiaries have all the directors from the U.S.A. As against this, in the case of 2 subsidiaries, the U.S. corporations have only equity investment and they are controlled by the Indian directors. In 9 subsidiaries, the majority control is in the hands of U.S. directors whereas in the same number of other cases, the U.S. direc— tors are in minority. In the remaining 4 subsidiaries, the management is shared equally by the Indian and U.S. directors. 77 Table 3:7.--Nature of management of participating subsidiaries. Participating Subsidiaries Number of Directors Percentage Number of Total 1. All U.S. Directors 3 11.1 2. Majority U.S. Directors 9 33.3 3. U.S.-India Directors Equal . 4 14.8 4. Majority Indian Directors 9 33'3 5. All Indian Directors _2_ 7.5 Total 21 100.0 Assets Size of Participating Subsidiaries The distribution of the participating subsidiaries and their contribution in the different assets size groups is given in Table 3:8. The seven subsidiaries with assets below $2.08 million accounted for only 2.16% of total assets of the participating subsidiaries. As against this 6 giant sub- sidiaries with assets of $20.92 million and above own 67.55% of the total assets of the remaining subsidiaries. Sales Size of Participating Subsidiaries Table 3:9 shows the sales size of the 27 partici- pating subsidiaries. 78 Table 3:8.--Size classification Of 27 participating sub- sidiaries based on total assets for the year 1963. Participating Assets in a Subsidiaries Million Dollars Assets Percentage Percentage Number Of Total Assets Of Total 1. Less than $2.08 7 25.93 8.640 2.16 2. $2.08 and less than $4.20 2 7.40 6.549 1.64 3. $4.20 and less than $8.36 5 18.52 31.569 7.89 4. $8.36 and less than $20.92 7 25.93 83.087 20.76 5. $20.92 and above _6 22.22 270.373 67.55 Total 2_ 100.00 400.218 100.00 aIn millions of dollars. Table 3:9.--Size classification of 27 participating sub- sidiaries based on total sales for the year 1963. Participating Sales in a Subsidiaries Million Dollars Sales Percentage Percentage Number of Total Sales of Total 1. Less than $0.52 7 25.93 1.446 0.46 2. $0.52 and less than $1.05 1 3.70 0.626 0.20 3. $1.05 and less than $2.09 4 14.81 6.270 1.98 4. $2.09 and less than $5.23 4 14.81 12.377 3.92 5. $5.23 and above 11 40.75 295.161 93.44 Total 21 100.00 315.880 100.00 aIn millions of dollars. 79 The seven subsidiaries with sales less than $0.52 million accounted for only 0.46% of total sales of all the participating subsidiaries. The 11 giant subsidiaries with sales of $5.23 million or above contribute 93.44% of the total sales of the participating subsidiaries. The remaining 6.10% of the total sales is contributed by 9 subsidiaries. Net WOrth Size of Participating Subsidiaries Net worth size of 27 participating subsidiaries is given in Table 3:10. Table 3:10.-'Size classification of 27 participating sub- sidiaries based on net worth for the year 1963. Participating Net WOrth in Subsidiaries Million Dollars* Net WOrth Percentage Net Percentage Number of Total Worth of Total 1. Less than $0.52 3 11.12 0.892 0.53 2. $0.52 and less than $1.05 4 14.81 3.791 2.25 3. $1.05 and less than $2.09 2 7.41 2.348 1.39 4. $2.09 and less than $5.23 12 44.44 49.132 29.10 5. $5.23 and above _6 22.22 112.649 66.73 Total 2 100.00 168.812 100.00 aIn millions of dollars. *The dollar figures of Tables 3:9, 3:10 and 3:11 are price-level adjusted amounts converted into dollars. U a 5! .m. yFU 80 Three subsidiaries with the net worth less than $0.52 million contribute only 0.53% of the total net worth of all the participating subsidiaries. As against this, there are 6 giant subsidiaries with net worth amount not less than $5.23 million own 66.73% of the total net worth of the participating subsidiaries. The remaining 32.74% Of the total net worth is owned by 18 participating subsidiaries. The participating subsidiaries represent the cross- section view of the total population. The groups of par- ticipating subsidiaries cover a variety of industries; include both very large and relatively small subsidiaries; both mature subsidiaries (including those which had been in India prior to the World War II) and new subsidiaries that started their Operation only within the last few years; subsidiaries that are fully established and have considerable access to sources of funds and subsidiaries that are quite new; subsidiaries which are wholly or majority owned and subsidiaries which are managed by the Indian partners. In short, the participating companies constitute a reasonable cross-section of the U.S. subsidi- aries but differ considerably from each other. x— n I Pvt *1 \v . 011‘ 5. Ann on» is .s\ 81 PART II Questionnaire Survey To get information regarding Objectives of invest- ment, factors influencing foreign investment decisions, techniques used in scrutinizing foreign investment projects, practice of applying capital budgeting techniques in inter— national investment, nature and influence of risk elements in foreign investment decisions, standard of performance expected by the parent corporations, general attitudes re- garding Indian investment climates, etc., it was decided to contact, through questionnaire, the parent corporations of all the participating subsidiaries. In designing of questionnaire, every attempt was made to make it concise so that the total time to complete it should not exceed 20 minutes. This was purposely done to solicit better response from parent corporations. The preliminary questionnaire was sent to two U.S. corporations for pre-testing purposes. One of them re- sponded and offered many valuable comments and suggestions for the improvement of form and contents of questionnaire. The pre-testing was also helpful in deciding the total time required to complete the questionnaire. The revised questionnaire was sent to the vice- president in charge of foreign or international Operations of all 27 parent corporations in the U.S.A. Wherever pos- sible the questionnaire was sent in the personal name of 82 these executives. A copy of covering letter and question- naireare attached in the Appendix. The covering letter indicates the total time required to complete the question- naire along with a promise to provide a summary of the response Of the questionnaire to all the respondents. A follow-up letter with a copy of questionnaire was sent in cases where the initial letter was not responded within 40 days. Response of Questionnaire ‘ Survey Out of 27 U.S. corporations, l7 corporations (63% of the total) responded. Out of these,three corporations refused to complete the questionnaire and the remaining 14 corporations (52% of the total population) filled out and returned the questionnaire. The details of the mail- ing and completed questionnaires are given in Table 3:11. Table 3:ll.--Distribution and return of questionnaires. Mailing Return Industry Number Percentage Number Percentage 1. Metal & Metal Products 3 11.1 1 7.1 2. Electrical Goods 1 3.7 - - 3. Machinery Equipment 5 18.5 3 21.5 4. Transport Equipment 4 14.8 1 7.1 5. Chgfiiigiczgiical 5 18'5 2 l4 3 6. Petroleum 2 7.5 14.3 7. Other 7 25.9 35.7 Total 27 100.0 14 100.0 83 The above table indicates that the response of the questionnaire is fairly representative in all the indus- trial groups. Moreover, it is also representative as to size of subsidiaries. PART III Personal Interviews To understand the various problems in-depth and to get an overall view regarding the investment policy and performance of the U.S. subsidiaries, an interview of the top executives of eight U.S. corporations was conducted. These corporations were selected on the basis of their willingness to participate in the interviews. The limita- tion of time and the resources of the author were also responsible in selecting the above parent corporations. The Indian subsidiaries of these U.S. corporations are engaged in different industries and vary in size, age and ownership. Moreover, the U.S. corporations operate in many foreign countries and possess operating experience of many years. In most cases the executives interviewed were chief executives in charge of international operations or of the Indian subsidiary. In some cases, more than one executive was interviewed. In many cases these executives have stayed in India for a number of years. 84 Each interview lasted for two to three hours. In order to proceed properly, an interview guide was prepared (see Appendix 2). The normal procedure followed for the interview was to start with a brief history of their opera- tion in India. This was followed by a description of the techniques and the procedures adopted by the parent corpora— tions for deciding the foreign investment. In some cases, the parent corporations showed their actual reports for the evaluation of the investment opportunity in foreign countries including India. Then the financial policy and performance of their Indian subsidiaries were discussed. This was followed by the nature of the various risks associated with the investment in India. The various problems and the overall impression of the parent corpora- tions were also discussed. In discussing the policies, etc., corporate position rather than the Opinion of the individual executives was asked. Besides these executives, the two government of- ficials of Indian Investment Centre in New York, were also interviewed. The main purpose of interviewing these people was to know their views and the government's attitudes in attracting the U.S. investors in India. The various prob- lems raised by the executives of parent corporations were also discussed with these Indian government representatives. The personal interviews were conducted in a con- genial atmosphere. While discussing the Indian subsidiary, VT' V_ F . Rn : VOA‘ 85 the experience of doing business in other foreign countries particularly in Asia and Latin American countries was also solicited. As has been pointed out earlier, the financial statements will be used as the primary source of informa- tion for the study of the investment policy and performance Of the subsidiaries and their parent corporations. These financial statements need to be adjusted for comparative study purposes. This forms the subject matter of the next chapter. CHAPTER IV PRICE LEVEL ADJUSTMENT AND COMPUTATION OF NET INCOME Overall View As has been pointed out in Chapter I, the main purpose of the present research is to analyze and evaluate the investment policy and performance of the U.S. subsidi- aries in India. Comparing by means of financial ratios, the investment policy and performance of the subsidiaries with their parent corporations will be a major part of the research, the comparisons to be based on the financial statements of the parents and subsidiaries. Since the price level change in India was much greater than the U.S.A. during 1963-67, use of published Indian financial statements without price level adjustment would reflect inflationary profit and would not give a correct estimate of the economic performance and value of the subsidiaries. The main reason for adjusting the financial state- ments for the price level changes is that the purchasing power of the monetary unit in which the financial state- ments are expressed changes inversely with the price level changes. This affects the economic value of the investment 86 87 which cannot be determined prOperly without taking into account the price level changes. To measure the economic values involved, the fi- nancial statements of the subsidiaries have been adjusted, on the basis of an adjusted consumer price index for price level changes in India. The financial statements of parent corporations have not been adjusted but the price level change in the U.S.A. has been allowed for while adjusting the financial statements Of their subsidiaries. The price level adjusted financial statements of the subsidiaries are used as the basis for the ratio study of the investment policy and performance of the subsidiaries. The chapter is divided into three parts. The first part discusses the technique and procedure adopted for the price level adjustment. The second part describes the pro- cedure adopted for the computation of net income figure Of the U.S. subsidiaries. The third part explains the dif- ference in the computation of return from parent and sub- sidiary viewpoints. PART I Price Level Adjustment As has been pointed out in Chapter II, the Indian economy witnessed a substantial rate of inflation during the period under study; the Consumer Price Index increased 88 from 116.1 (1958 = 100) in 1963 to 180.5 in 1967. In other words, the general price level increased by 56% in five years. As against this, the Consumer Price Index in the U.S.A. increased from 106.7 (1957-59 = 100) in 1963 to 116.3 in 1967 (see Figure 4.1), i.e. the general price level increased by 9.0% in these years. Due to this in- crease in the general price level, the purchasing power of the monetary unit has declined. The financial state— ments of U.S. subsidiaries and parent corporations, prepared per conventional accounting on the assumption of stable monetary unit, do not represent the same purchasing power of their respective unit for the different years. Thus, the 1963 rupee is not the same as that of the 1967 rupee. In the same way, the dollar of 1963 does not express the same purchasing power as the dollar of 1967. The purchas- ing power Of Indian currency declined by 36% during 1963 and 1967 whereas the purchasing power of the dollar de- creased by 8% in these years. As Finney and Miller rightly point out: "Many of the dollar amounts shown in comparative financial statements are 'Old' dollars. Therefore, comparative statements are likely to be misunderstood because of variations in the purchasing power of the dollars."1 This opinion expressed 1Harry A. Finney and Herbert E. Miller, Principles of Financial Accounting--A Conceptual Approach, (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1968), pp. 341-342, 89 Figure 4.1.--Consumer price index of U.S.A. and India Index 180% 170‘ l 4 60 ‘7 India (l958=100) 150* 140% 130‘1 U.S.A. 120' (1957-59:100) 110‘ 100 [—— 0'7 1963 1964 1965 1966 1967 Year Source: See Table 4:1. 90 in the context of the dollar is also applicable in the case of Indian currency. Some hold the view that the historical financial statements should be adjusted for the changes in the pur- chasing power of monetary unit. The Accounting Principles Board Of the American Institute of Certified Public Ac- countants on November 4, 1960 has expressed its Opinion that it is unrealistic to ignore the fluctuation in the value of the dollar. Further it is feasible to give rec- ognition to the effects of price level changes on finan- 2 The Accounting Research Study NO. 6 sup- cial statement. ports the above View and has pointed out that as the degree of inflation in the U.S.A. increases materially, there would be many corporations which would adjust their finan- cial statements for price level changes.3 The Committee on Concepts and Standard Underlying Corporate Financial Statements of the American Accounting Association also studied the problem of price level changes and came to the conclusion that management may present the effects of fluctuation in the value of the dollar upon net 2A3 quoted from Staff of Accounting Research Div- ision, Reporting The Financial Effects of Price Level Changes (New York: American Institute of Certified Public Accountants, 1963), p. 1. 3Ibid., p. l. 91 income and upon financial position.4 In the study of the comparative financial statements of four companies both on historical dollars and uniform-common dollars (price level adjustment) for the year 1941 to 1951, Ralph C. Jones con— cluded that the adjustments of the financial statements for the price level change have a significant effect on the net earnings of these companies. "The substantial inflation which has cut the purchasing power of the dollar by about half since 1940 has considerably impaired the usefulness of financial statements based entirely on historical costs."5 Perry Mason made a study, on the basis of the four companies, of the possibility of improving the usefulness of conventional accounting figures by restating them with the use of a general price level index. He concluded that without adjustment, the figures of financial statements suffer from lack of comparability.6 Despite agreement on price level adjustment, there is no well-accepted view regarding the technique to be 4American Accounting Association, Price Level Changes and Financial Statements, The Accounting Review, Vol. XXVI, No. 4, October 1951, p. 472 5Ralph C. Jones, Price Level Changes and Financial Statements—-Cases of Four Companies (Evanston, Ill.: Ameri- can Accounting Association, 1955), p. 177. 6Perry Mason, Price Level Changes and Financial Statement--Basic Concepts and Method (Evanston, Ill.: American Accounting Association, 1967), p. 11. 92 adopted for the price level adjustment. There are two broad techniques which are suggested. The first approach recommends adjusting only those items of the financial statements (such as long-term assets, depreciation charges, inventory) which are expressed in historical costs and are severely affected by price level changes. The adjustment is achieved by the use of specific price index numbers. Under this method the main purpose is to arrive at the current replacement cost or the equivalent in terms of services rendered by the assets. The American Institute of Certified Public Accountants and American Accounting Association do not favor this partial adjustment because they believe the measurement of price level change should take into account all the items of the financial statements.7 The second method favors the adjustment of all items of financial statements on a constant-value unit equivalent to the purchasing power of the monetary unit of a selected period. The historical figures as recorded on the books should be converted into a constant-value unit by applying a general index of price. The AICPA (not formally) and AAA recommend this approach. The author has 7Staff of the Accounting Research Division, 33: porting the Financial Effects of Price-Level Changes, 0 . cit., p. 54; American Accounting Association, Price LeveI Changes and Financial Statements, op. cit., p. 471. 93 followed this technique for the price level adjustment for the present study. Selection of Index Number8 There are two types of price indexes, i.e., speci- fic price indexes and general price indexes. The specific price indexes measure the price movement for specific commodities and services whereas the general indexes re- flect the changes in the price level prevailing in the economy as a whole. Since the author is adjusting all the items of the financial statement, the index number adopted for this purpose should measure the changes in the price level in general reflecting changes in the general purchas- ing power of the monetary unit. There are three primary general price indexes in the U.S.A., i.e., Gross National Product Implicit Price Deflators, Wholesale Price Index and Consumer Price Index. In India, there are primarily two general price index numbers, i.e., a Wholesale Price Index and a Consumer Price Index. The GNP Implicit Price Deflators prepared by the U.S. Department of Commerce is the most comprehen- sive and the best currently compiled index of the general 8For a detailed discussion of the index number, see Staff of Accounting Research Division, Reporting The Financial Effects of Price Level Changes (Accounting Re- search Study No. 6), op. cit., esp. Appendix 'A' on 'The Index Number Problem' by Cecilia Tierney, pp. 61-117. (j. (D 11"! 1‘, 94 level of prices in the U.S.A. This index measures the relationship between the total value of all goods and services produced in a given year expressed in current dollars and the total value of the same goods and services expressed in prices of a base-year constant dollars. This index reflects all exchange prices in the economy. There is no such index number in India and hence the question Of the use of this index does not arise; rather the choice falls between the wholesale price index and the consumer price index. The Index of Wholesale Price gives heavy weight to raw materials and semi-finished goods and does not re- flect the price behavior of the many goods and services. "It is not a measure of 'wholesale price' as its name implied but a measure of ggmg wholesale prices in specific markets."9 The Consumer Price Index is a widely used in— dex for the general price level changes in many countries. Moreover, this index is much broader than the wholesale price index. It reflects primarily the prices of finished goods and services and thus measures the changes in the cost-of-living. For the present study, the consumer price index is used as the measure reflecting the change in the general price level and hence the general purchasing power of monetary units. At the very outset, it should be pointed 91bid., p. 73. 95 out that the preparation of the consumer price index is based on many assumptions and limitations. Any adjust— ment based on this index number is bound to reflect these assumptions and limitations and may affect the price level adjustment. Moreover, the consumer price index may not reflect all the prices in the economy but "no index of all prices in the economy has ever been computed and none is likely to be computed."10 Adjustment of Consumer Price Index To make proper adjustment for price level changes, the financial statements of parent corporations should be adjusted on the basis of the Consumer Price Index prepared by the U.S. Bureau of Labor whereas the financial state- ments of U.S. subsidiary should be adjusted with the help of the Consumer Price Index prepared by the Labour Bureau, Government of India. But the financial statements of parent corporations are not adjusted for the changes in the price level in the U.S.A. because the price levels in the U.S.A. during these years were relatively stable (i.e. a 9% increase over the period of five years). However, this does not mean that the price changes in the U.S.A. ‘were ignored in adjusting the financial statements of the {1.5. subsidiaries. 10Eldon S. Hendriksen, Accounting Theory (Homewood, 1114.: Richard D. Irwin, Inc., 1965), p. 178. 6 0c U LA.- 5 H"? “on: ing 1.16 ‘ Q 1 m d ‘ul 4",. d... 96 In order to make proper adjustment, and to com- pensate for the increase in the price level in the U.S.A. as reflected in the U.S. Consumer Price Index, the Con- sumer Price Index of India was reconstructed after adjust- ing for the annual increase in the Consumer Price Index in the U.S.A. The adjusted Consumer Price Index of India re- flects only the changes in the general price level after making allowance for the increase in the U.S. Consumer‘ Price Index. The financial statements of the U.S. sub- sidiaries have been adjusted on the basis of this adjusted Consumer Price Index of India. The same technique is fol- lowed for the adjustment of the 4th quarter and the year-end indexes of the Consumer Price of India from that of the 4th quarter and the year-end indexes of U.S. Consumer Price. Table 4:1 gives the unadjusted Consumer Price In- dexes of the U.S.A. and India and the adjusted Consumer Price Index of India. After adjusting the consumer price index for the different periods the conversion ratios and the multipliers ‘were calculated from the adjusted consumer price index on the basis of common-monetary unit. All the items (all five years) are being adjusted to the December 31, 1967 price Level. Thus the price index as of December 31, 1967 is 'used.as the numerator and the price index applicable to the previous period is used as the denominator. The multiplier is arrived after dividing the numerator by the denominator. CU m [Hm «H adPF~HH MW F— Arvu muwv‘vm: aunt/N M fV—pufid m A n AIUMIU «v3.4 mu 3 .5 ~J 5:3 «J Pu fr vfipwvu .n- y“ rva u, .Hse «i I (r/ I“ thp-~ u 9&- n h n: -. val! .Hmm» mmma on» no mmlhmma mo manna mnu co omnmmwum ma NOOGH moaum Hmfidmcoo .m.o may Omsmomn How» Oman on» no mmma on oomqmso soon mm: were .umom Oman was no mvma mo manna wnu so omummmnm ma mwosH mo xoosH OOHHA HmESmGOU one “muoz .AOHOGHV monfiom .cwumaasm MHUCH mo xcmm m>ummmm one Amy A.U.o .coumaflnmmg .moammo mcflucwum puma Icuw>oo m.Dv mmmcwmsm ucwunso mo N0>Hsm .OOHOEEOU mo ucmspummmo .m.D Adv umOOHSOm 97 m.mmH s.HmH N.mHH .Hmsossoooo MhMMH bhhmH m.bHH Houumso sun «.mmH m.oma m.oHH moms m.mva o.ooa n.4HH .Hm sossoooo ”.mNH N.NMH m.NHH Hounmso sum o.H8H ~.ooH H.mHH moms o.~ma o.osa o.HHH .Hm nonsmooo .mhme m.mmH h.oHH soososo spa m.oma ~.moa o.ooH moms o.s~a o.mma m.moH .Hm sonsoooo D.an HthH “.mmH Hounmso nun o.m~H o.mma H.moa woos ~.oHH o.oHH o.soa .Hm mongoose “.moH m.nHH n.5pH Hounmso gum m.moa H.oHH s.ooa mooa . Awe sac cos x Hiaoaoo 8 Amoaooi Aooaummoav Aooauomusmoao oHosH .<.m.o. oonuoo MaoCH mo xoocH xOUsH moanm moaum Hmfidmcoo omumsno< hoesmsoo omumsnomco .MHUGH can .<.m.D mo moxmosfi.OUHHQ.HOEOchOII.Huv manna .1 "2 t \- O "l :{‘ I“ l 'I a , fl 0.... bu '1 (D O. .Q. I"... V“ 98 These multipliers are used for the adjustment of the various items of the financial statements of U.S. sub- sidiaries for the price level changes. The conversion ratios and multipliers are given in Table 4:2. Ad'ustment of Balance Sheet for Price-Level Changes There are two approaches in accounting for the measurement of net income of a business entity, i.e., transaction approach and balance sheet or capital (equity) maintenance approach. Under the transaction approach, the income is the excess of revenues over expenses. The revenues and expenses are recorded as changes in assets and equities resulting from an entity's transactions. Under the balance sheet approach, the income is arrived after taking into account the maintenance of capital, and income cannot emerge until "capital" in this case, purchasing power, is maintained. For the present study, the balance sheet approach to the measurement of net income has been adopted and only the balance sheet items have been adjusted on a common currency value expressed in terms of December 31, 1967 price level. 11 TO illustrate the procedure adopted for the price level adjustments let us start with an example of subsidiary's 11Total sales figures have also been adjusted for computing rates of return on total sales discussed in Chapter VI. FLUJ 1. . F14 O J g L ‘i‘ 99 Table 4:2.--Mu1tipliers for price level adjustment. Adjusted Consumer . . Conversion . . Period Price Index Multiplier of India FaCtor 1963 Annual Average 108.8 153.3/108.8 1.409 4th Quarter 109.7 153.3/109.7 1.397 December 31 110.2 153.3/110.2 1.391 1964 Annual Average 123.0 153.3/123.0 1.246 4th Quarter 127.0 153.3/127.0 1.207 December 31 127.6 153.3/127.6 1.201 1965 Annual Average 130.3 153.3/130.3 1.176 4th Quarter 132.4 153.3/132.4 1.158 December 31 132.0 153.3/132.0 1.161 1966 Annual Average 141.6 153.3/141.6 1.083 4th Quarter 143.4 153.3/143.4 1.069 December 31 145.5 153.3/145.5 1.053 1967 Annual Average 155.2 153.3/155.2 0.989 4th Quarter 155.3 153.3/155.3 0.987 December 31 153.3 153.3/153.3 1.000 ¥ y}. A~¥ 100 (rupee, historical cost) statement given for the five years in Exhibit 4.1. Assumptions.--The adjustments of the historical balance sheet figures for price level changes have been made after taking into account the following assumptions. (1) Fixed assets and capital stock prior to the year 1963 are assumed to be acquired or issued in 1963. The same assumption is made for the accumulation of allowance for depreciation prior to the year 1963. (2) Fixed assets acquired prior to the year 1963 and during 1963-67 were not retired. (i.e., The fixed assets increase during any period is the net of additions minus retirements; in the absence of data on retirements, the net increase is assumed to represent gross additions). (3) The year-end inventories were acquired in the 4th quarter of each year and the price index of the 4th quarter of each year is used for adjustment purposes. (4) In a few cases, the closing date of the balance sheet is different from that of December 31. In such cases it is assumed that the balance sheet is prepared as on December 31 of each year. Adjustment Procedure.--The following description explains the adjustment procedure: (Refer to Exhibit 4.2, 101 Exhibit 4.l.--Ba1ance sheet of a subsidiary for five years (1963-67). (Rs. in '000.) 1963 1964 1965 1966 1967 Assets Cash 3,152 1,034 3,604 2,734 1,138 Accounts receivable 3,927 4,063 6,012 7,472 9,453 Inventories 9,553 11,469 10,514 12,465 15,820 Total Current 16,632 16,567 20,131 22,672 26,411 Assets Other assets 6,531 8,552 19,344 26,543 33,032 Fixed assets (Gross) 15,737 16,186 16,712 16,948 17,826 Less depreciation (4,594) (6,033) (7,537) (9,025)(10,607) Net fixed assets 11,142 10,154 9,175 7,923 7,219 Total 34,305 35,274 48,652 57,168 66,662 Liabilities Accounts payable 3,033 1,876 3,879 4,500 4,902 Provisionsa 12,829 16,139 24,656 34,257 40,221 Total Current Liabilities 15,863 18,015 28,536 38,758 45,123 Long term debt 2,031 1,719 4,501 1,094 2,781 Common stock 7,149 7,014 7,014 7,014 7,014 Retained earnings 9,263 8,526 8,601 10,301 11,844 Total 34,305 35,274 48,652 57,168 66,662 a I O I O O 0 Include prOV1Slons for taxation, d1v1dends, contin- genc1es, etc. 102 Exhibit 4.2.--Price level adjustment of a sample balance sheet for 1963—1967 (figures in thousands). 1963 1964 Higgir- Multi- Adjusted Higzir- Multi- Adjusted Rs. plier Rs. Rs. plier Rs. (1) (2) (3) (l) (2) (3) Assets Cash 3,152 1.391 4,384 1,034 1.201 1,242 AC¢°unFS 3,927 1.391 5,462 4,063 1.201 4,880 receivable Inventories 9,553 1.397 13,346 11,469 1.209 13,843 Total Current Assets 16,632 23,192 16,567 19,965 Other assets 6,531 1.391 9 085 8,552 1.201 10,271 Fixed assets (gross) 15,737 22,173 16,186 22,732 Acquired in: 1963 15,737 1.409 22,173 15,737 1.409 22,173 1964 449 1.246 559 1965 1966 1967 Accumulated 4,595 6,474 6,033 8,266 Deprec1ation '_—‘_—' '—_"—' -_————— 1963 4,595 1.409 6,474 4,595 1.409 6,474 1964 1,438 1.246 1,792 1965 1966 1967 Net fixed assets 11,142 15,699 10,154 14,466 Total 34,305 47,976 35,274 44,702 103 1965 1966 1967 ffiziir- Multi- Adjusted Hizzgr- Multi- Adjusted Hizzir— Multi- Adjusted Rs. plier Rs. Rs. plier Rs. Rs. plier Rs. (1) (2) (3) (l) (2) (3) (1) (2) (3) 3,604 1.161 4,184 2,734 1.053 2,879 1,138 1.000 1,138 6,012 1.161 6,980 7,472 1.053 7,868 9,453 1.000 9,453 10,514 1.158 12,175 12,465 1.069 13,325 15,820 0.987 15,614 20,131 23,339 22,672 24,072 26,411 26,205 19,344 1.161 22,459 26,572 1.053 27,981 33,032 1:000 33,032 16,712 23,351 16,948 23,607 17,826 24,475 15,737 1.409 22,173 15,737 1.409 22,173 15,737 1.409 22,173 449 1.246 559 449 1.246 559 449 1.245 559 526 1.176 619 526 1.176 619 526 1.176 619 236 1.083 256 236 1.083 256 7,537 10,035 9,025 11,442 10,609 13,211 4,595 1.409 6,474 4,595 1.409 6,474 4,595 1.409 6,474 1,438 1.246 1,792 1,438 1.246 1,792 1,438 1.246 1,792 1,504 1.176 1,769 1,504 1.176 1,612 1,504 1.176 1.769 1,488 1.083 1,564 1,488 1.083 1.612 1,582 0.989 1,564 9,175 13,316 7,923 12,165 7,219 11,264 48,652 59,114 57,168 64,218 66,662 70,501 Exhibit 4.2 Continued. 104 1963 1964 H15tor’ Multi- Adjusted H?St°r' Multi- Adjusted 1ca1 lier Rs 1ca1 plier Rs Rs. p ’ Rs. ' (l) (2) (3) (1) (2) (3) Liabilities Accounts payable 3,033 1.391 4,216 1,876 1.201 2,253 Provisions 12,829 1.391 17,845 16,139 1.201 19,383 Total Current Liabilities 1.51.8.6}. 32.41.21 M M Long term debt 2,031 1.391 2,825 1,719 1.201 2,065 Common.stock 7,149 10,073 7,014 9,905 1963 7,149 1.409 10,073 7,149 1.409 10,073 1964 -135 1.246 -168 1965 1966 1967 Retained earnings 9,263 13,017 8,526 11,096 Total 34,305 47,976 35,274 44,702 105 1965 1966 1967 :55“”“'Mu1ti- Adjusted_ H¥St°r' Multi- Adjusted H53t°r' Multi- Adjusted 5: lcal plier Rs 1cal plier Rs 1ca1 plier Rs .3 RS. ' Rs. . RS. . (l) (2) (3) (l) (2) (3) (1) (2) (3) 1879 11161 4,504 4,500 1.053 4,739 4,902 1.000 4,902 ;;24656 11161 28,626 34,257 1.053 36,073 40,221 1.000 40,221 ,28fi36 33,130 38,758 40,812 45,123 45,123 4,mn. 1.161 5,226 :1,094 1.053 1,152 2,781 1.000 2,781 ,‘L014 9,905 7,014 9,905 7,014 9,905 7A49 1.409 10,073 7,149 1.409 10,073 7,149 1.409 10,073 -435 1.246 -168 -135 1.246 -168 -135 1.246 -168 ,Jhéfll 10,853 10,301 12,349 11,844 12,692 4 éééia 59,114 57,168 64,218 66,662 70,501 106 columns (1), (2) and (3).) (a) Cash, Accounts Receivable, etc: The cash, accounts receivable, marketable securities and other mone- tary assets of each year are adjusted in terms of December 31, 1967 price. For instance, Rs. 3152 of cash at December 31, 1963 (column (1)) has a purchasing power equivalent to Rs. 4384 (column (3)) at December 31, 1967 price, i.e., Rs. 3152 x 1.391 (153.3/110.2) and that Rs. 1034 of cash at December 31, 1964 is equivalent to Rs. 1242 at December 31, 1967 price level (Rs. 1034 x 1.201). The cash amounts of Rs. 3879 at December 31, 1965 and Rs. 2734 at December 31, 1966 have a purchasing power equivalent to Rs. 4504 (Rs. 3879 x 1.116) and Rs. 2879 (Rs. 2734 x 1.053) respec- tively at December 31, 1967 price. The cash amount at December 31, 1967 requires no adjustment because it is automatically exPressed in the rupee of that date. The same procedure is followed for accounts receivable, mar- ketable securities and other monetary assets. (b) Inventory: The year-end inventory is converted at the average price of the last quarter of each year with the assumption that they were acquired at the average rupee value of the last quarter of each year. For instance, the inventory of Rs. 9553 at December 31, 1963 (column (1)) assumed to be acquired at the average price for the last quarter of 1963 and were adjusted to Rs. 13346 (column (3); Rs. 9553 x 1.397). The same procedure is followed for each year. 107 (c) Fixed assets: The fixed assets as of year-end 1963 have been adjusted by multiplying the recorded amount by the multiplier of 1.409 (153.3/108.8). Thus Rs. 15737 of the fixed assets (column (1) in 1963) has a equivalent purchasing power of Rs. 22173 (column (3)) at December 31, 1967 price level. The addition to the fixed assets in sub- sequent years has been adjusted by multiplying with the multiplier of each year. For instance, Rs. 449 of fixed assets added in the year 1964 has an equivalent purchasing power of Rs. 559 (Rs. 449 x 1.246) at December 31, 1967 price level. The same technique has been followed for the years 1965, 1966 and 1967. The amount of depreciation has been adjusted for the price level changes similar to 12 that of fixed assets. (d) Current Liabilities and Long Term Debts: For the adjustment of the current liabilities and long term debt, the procedure as followed in the case of cash, ac- counts receivable, etc. has been adopted. That is, each year's amounts of current liabilities and long term debt have been multiplied by the year-end multiplier of that year. 12Strictly speaking, the total depreciation amounts of each year do not represent the amount charged against the fixed assets of that particular year and hence a single multiplier for each year's depreciation allowance should not be used. But for the sake of simplicity, a single multiplier of each year is used for adjustment purposes. 108 (e) Common Stock: The common stock is adjusted like the fixed assets. The common stock prior to the year 1963 is assumed to be issued in the year 1963. Rs. 15737 of common stock of 1963 (column (1)) has a purchasing power equivalent to Rs. 22173 (column (3); Rs. 15737 x 1.409) at December 31, 1967 price level. The addition in the common stock in each year has been adjusted at the year-average multiplier of the respective year. (f) Retained Earnings: The amounts of retained earnings in the adjusted balance sheet (column (3)) are simply the residuals required to balance the accounts. This balance of the retained earnings represents the com- pletely adjusted undistributed earnings or loss, plus or minus the gains and losses on all the items of the balance sheet from price level adjuStment. The common stock and retained earnings taken together represent the amount of the stockholders' interest in the business after all the items have been adjusted for the change in the value of the rupees. PART II Computation of Net Income After adjusting the various items of the balance sheet the net incomes for the years 1963 to 1967 have been computed. The net incomes for these years were computed 109 by a comparison of the retained earnings at the beginning and end of the year after adjusting for the dividend of that year. The details are given in Exhibit 4.3. Column (1) analyzes the net income as reported (historical cost basis) in the income statement of the subsidiary for each year. Column (2) gives the net income as derived after making provIEEBng r the price.1evel'ad— justment. It is arrived on the basis of the capital main- tenance concept of income and is, therefore, an all in- clusive income (Note especially inclusive of purchasing power gain or loss). Assumptions for Computation 0 Net Income The net income has been computed on the basis of the following assumptions: (1) The amount of the divident given in column (1) has been adjusted for the price level change (column (2)) on the basis of the adjusted year-average Consumer Price Index of each year. The amount of dividend has been assumed to be declared and paid uniformly throughout the year. (2) Since the information necessary to compute the price level adjusted retained earnings for the year- end 1962 is not available, the net income of 1963 (Rs. 2943) is adjusted by the use of price multi- plier of the year 1963 (i.e., 1.409) which comes to Rs. 4150 (Rs. 2946 x 1.409). 110 Exhibit 4.3.--Samp1e computation of net income for 1963-1967 (Figures in thousand rupees). 1963 1964 Historical Adjusted Historical Adjusted (l) (2) (l) (2) Stated retained earnings at cur- 9,263 13,017 8,526 11,096 rent year-end Correctiona - - +1,654 +2,061 Year-end retained earnings 9,263 13,017 10,180 13,157 Plus Dividend paid 2,400 3,382 2,805 3,495 Total 11,663 16,399 12,985 16,652 Less retained earnings at Pre' 8 720 - 9 263 13 017 vious year-end ' b ' ' Net Income 2,943 4,150 3,722 3,635 1965 1966 1967 Hist. Adjusted Hist. Adjusted Hist. Adjusted (l) ‘(2) (1) (2) (1) (2) State retained earnings at cur- 8,601 10,853 10,301 12,349 11,844 12,692 rent year-end Correctiona -1,814 -2,133 -207 -224 -710 -702 Year-end retained earnings 6,787 8,720 10,094 12,125 11,134 11,990 Plus.d1V1dend 4,347 5,112 3,155 3,417 3,156 3,121 paid —————— -—————- Total 11,134 13,832 13,249 15,542 14,290 15,111 Less retained earnings at previous 8,526 11,096 8,601 10,853 10,301 12,349 year-end Net Income 2,608 2,736 4,648 4,689 3,989 2,762 aRefer to Item 3, p.111 bRefer to Item 2, p.109 111 (3) The amount with the (a) shows the differenCe be- tween the net income as reported in the subsidiary's published income statement for each year and the net income amount as arrived by the aggregation of the retained earnings of the current year plus dividend minus retained earnings of the previous year. In fact, there should not have been any difference between the net income figure as shown in the income statement and the net income figure as arrived through this method. This difference is due to the retained earnings reserve figures. This difference has been seen in a few subsidiaries and care has been taken to correct this difference. PART III Return: Parent Versus Subsidiary Viewpoint The translation (into dollars) of the financial statement of a foreign subsidiary is often recommended on the following grounds:13 1. Since the U.S. parent company's investment is in dollars, the operatiOns of the foreign subsidiary must be expressed in dollars in order to evaluate the return produced by the dollar investment. 13National Association of Accountants, Management Accountin Problems in Foreign Operations, (New York, March I935), pp. 10-11. 112 2. Management in the United States is accustomed to thinking in terms of dollars rather than in foreign currency units. 3. The objective of business operations abroad is profit which benefits shareholders of the U.S. parent company through dividends paid in U.S. dol- lars or through an increase in dollar values of the U.S. shareholders' equity. Translation of local currency is a prerequisiteto determining_the periodic loss or gain sustained by the U.S. parent company from movements in exchange rates. This figure mea- sures the degree of success which management has had in protecting the U.S. company's dollar invest- ment against erosion from currency depreciation. [Emphasis supplied] 4. In order to consolidate foreign financial state- ments with domestic statements, all of the state- ments to be consolidated must first be expressed in homogeneous monetary units. Among the above reasons, the determination of the periodic gain or loss sustained by the U.S. parent company from movements in exchange rate appears to be of paramount im- portance for this study. When the rate of exchange changes greatly, the translation of the financial statements of foreign subsidiary from the foreign currency into dollars would, no doubt, provide substantially different results. Under such a situation, the translation would be essential to fully determine the parent's financial interests. The rate of exchange at which the Indian currency is converted into a stable foreign currency has fluctuated within a narrow range. In other words, throughout the 1963-67 period of this study, the dollar-rupee exchange rate remained fairly stable (except for the devaluation of 1966). Under such circumstances, it may be argued that 113 translation of the balance sheets of the subsidiary into dollars would produce more or less identical ratio rela- tionships. Thus the main argument for translating the balance sheet of the U.S. subsidiary into dollars (from the parents' vieWpoint) would be to take into account for- mally the exchange loss suffered by the parent corporations on account of the devaluation of the Indian currency which occurred during the period under study (i.e. on June 6, 1966). However, for this study the computation of income is important ngh_from the subsidiaries' and parents' vieWpoint. We are interested in the subsidiaries' rate of return as they operate in the Indian economy and the business risk (variability) associated with their perfor- mance. We are also interested in the parent corporations' income (change in dollar-measured equity) and rate of return on their equity. In the present study, the annual income from each of the two vieWpoints would not be the same although the five-year average rate of return would be about the same. The main difference would be due to the differing pattern of inflation rates in both countries and the 1966 devaluation of the exchange rate. Let me illustrate this point with an example using the actual price level indices, as derived from Table 4:1 114 data, and exchange rates.14 Exhibit 4.4.--Illustration of the joint effect of host country inflation and exchange devaluation on the dollar value of a parent company's inveStment. Asset At Year-End Purchase (in 1963) 1963 1964 1965 1966 1967 Historical Cost A. rupees 478 478 478 478 478 478 B. dollars 100 100 100 100 100 100 Adjusted Rupees C. December 31, 1967 price index 746 746 746 746 746 746 D. Price index as of 488 574 602 688 746 each year-end E. Exchange Rates 4.78 4.79 4.78 7.57 7.56 ' (rupee) F. Equivalent Dollar Value 100 102 120 126 91 99 Assume an American parent company transmits in 1963 $100 to the Indian subsidiary. The subsidiary invests the 14The rate of exchange between Indian and U.S. cur- rencies is given as follows: As of Exchange Rate Qgcember 31 (One Dollar Equivalent To) 1963 Rs. 4.780 1964 Rs. 4.794 1965 Rs. 4.789 1966 Rs. 4.787 (January '66 to June 5,'66) Rs. 7.576 (June 6, '66 to Dec. 31, '66) 1967 Rs. 7.564 Source: International Financial Statistics, (Washington: International Monetary Fund) Vol. XXI, No. 12. 6‘ hid P.L. fl 1' 115 Rs. 478 obtained in an asset (non-depreciating, for simplicity's sake). Line A of Exhibit 4.4 shows how conventional (historical cost) accounting would treat that assets as it is held over the remainder of the five-year period. Con- ventional translation into dollars (which assumes histori- cal cost in the subsidiary's statements) uses the exchange rate in effect at the purchase date and thus the pattern resulting would be that of line B. Line C illustrates the method used for price level 15 that is, all statements were re- adjustment in this case; stated at the price level prevailing as of year-end 1967. The Rs. 746 thus represents the purchasing power invested in the asset in terms of the 1967 rupee, i.e., Rs. 478 times 1.56 (1.56 equals 181.4, the 1967 index, divided by 116.1, the 1963 index). Through this sort of adjustment, all the price level adjusted subsidiary statements were made internally consistent and comparable over time. Of course, the price level increase took place gradually while the exchange rate change (devaluation of the rupee) was sudden. Linesrn E:and F together illustrate their joint year-by-year effect on the dollar valuations of the economic value of the asset. Here a slightly dif- ferent approach to price-level adjustment is needed. Noting 15For the present study, the adjusted consumer price index has been used; for details, see p. 97 of this chapter. a: a: '1 I "I «I Kl) u.) n; 116 line D (1963), the Rs. 488 figure represents the original investment of purchasing power in terms of the year-end 1963 rupee-~there was a slight (1.7%) inflation during 1963 (478 times 1.017 = 488). Then, the Rs. 488 is trans- lated (line F) into dollars at the Rs. 4.78 = $1 exchange rate, which remained constant. Line F thus illustrates the effects, from the parents' view, of their capital gains from Indian infla- tion in every year, less in 1966 the capital loss from devaluation. The reasoning that the Line F value pattern actually does represent gains and losses to the parent is as follows. I am assuming that the "real" value of the asset in the Indian economy remains constant. This means that under inflation it is "worth" progressively more rupees, either in immediate sale or in any value derived from the value of its future output of "products." So long as the dollar-rupee exchange rate remains stable, the asset is thus worth progressively more dollars, a capital gain to the parent. However, devaluation of the rupee (while not influencing directly the rupee value of the asset) results in the asset being suddenly worth, either in sale or in use, less dollars, a capital loss to the parent. As line F also illustrates, the gains and the loss roughly offset. The price level increase of the five-year period was 56% while the devaluation in 1966 was 58%. 117 The income figures computed for the present study, after price level adjustment but not translated into dol- lars, exclude (1) parents' capital gains (in all years) from the price level adjustment (inflation with no exchange rate change) and (2) parents' capital loss from devaluation (in 1966). Thus the income figures represent essentially the subsidiary's experience in the Indian economy and hence the variability of return would be an indicative of business risk as it does not include the parents' capital gain or loss. From the parent company's viewpoint, the profit figures would have been higher in 1963, 1964, 1965 and 1967 if the capital gains were included in the computation of income figures but the income figures would have been lower in 1966 due to the exchange loss on account of de- valuation of Indian currency. These profit figures would have shown more variability in returns because of larger exchange loss in 1966 and higher rates of return in other years. But as indicated above, we can assume rough equality of these factors over five-year total returns (from parent corporations' viewpoint). Sunmwmy The present chapter described the techniques and procedures followed for the price level adjustment and computation of the net income of one subsidiary. The same 118 techniques and procedures described in the case of the example have been adOpted for all participating subsidi- aries. The financial statements of the parent corporations have not been adjusted. “Through the use of the "adjusted price-level index" (developed in Table 4.1) the parents and subsidiaries have been placed in a roughly equal position, so far as adjusting for the effects of inflation is concerned, in computing the comparative financial ratio (though the absolute amounts so derived are not meaning- ful). The adjusted financial statements of the U.S. sub- sidiaries and the unadjusted financial statements of the parent corporations have been used as the basis for the analysis of the investment policy and performance dis- cussed in Chapters V and VI. O 3') ‘2' CHAPTER V INVESTMENT POLICY The present chapter is divided into three parts. The first part discusses the objectives of the U.S. cor- porations for investing in India. The second part des- cribes the procedure and the practice of incorporating the capital budgeting theory in the field of international business investment. The last part tests the hypothesis regarding the investment policy of the U.S. subsidiary in India. The information for parts I and II is collected from library research, questionnaire survey and personal interviews whereas part III is mainly based on the ad- justed financial statements of the subsidiaries. The in- formation about the U.S. corporations was collected from the Moody's Industrial Manuals for various different years. PART I Objectives of Investment Why do U.S. corporations invest their capital in foreign countries? In other words, what is the motive for investing in the overseas operations? The general view is to earn profit from foreign operations. It is generally 119 120 assumed that to pursue and induce U.S. corporations to invest in and operate manufacturing facilities abroad, the rate of return on foreign investment should be higher than the U.S. return to compensate for the greater risk. A number of studies have been conducted regarding the ob- jectives of investing corporations in foreign countries. Barlow and Wender, and Gordon and Grommers point out that manufacturing companies invest abroad primarily to maintain a market.1 Casanova's article regarding the idealogy of the U.S. corporations concerning foreign in- vestment mentions that "the objective of foreign invest- ments is to solve the economic problems of the United States, which are related to over—production and the accu- mulation of capital." The policy of investment abroad is to obtain a higher rate of profit.2 The survey conducted by Dr. J. N. Behrman regard- ing the motives of companies investing abroad led to the conclusion that "the motives (are) complex and not singularly 1E. R. Barlow and Ira Wender, ForeignInvestment and Taxation, (Englewood Cliffs, New Jersey: Prentice- Hall, 1955), p. 160; L. Gordon and E. L. Grommers, United States Manufacturing Investments in Brazil, (Harvard Uni- versity, 1962) p. 148. 2Pablo G. Casanova, "The Idealogy of the United States Concerning Foreign Investment," Foreign Investment in LatinAmerica, (Edited by Marvin D. BernsteinYYNew York: .AIfred A. KnOpf, 1966), p. 238. 121 profit-directed."3 These motives include to increase ex- ports and imports, to obtain raw materials at lower costs from abroad, diversification and to maintain supplier re- lations with a customer. McLean has divided the sound business reasons for international investment into two categories--profit opportunities and competitive necessi- ties. A steadily increasing number of American-businesses are finding excellent growth prospects and rewarding profit Opportunities from participation in foreign industrial de- velopment. The development of local industries abroad has in some cases made it impossible from a competitive and economic standpoint to continue shipments from the U.S.A., and the manufacturers so affected have been forced to es- tablish plants abroad to retain their business.4 Falk emphasizes that there would be no plausible reason for expanding activities into a foreign market unless there was a distinct purpose and this purpose, in its last analy- sis, can be only additional profit. Whether the profit goal is achieved in the short-run or the distant future, 3J. N. Behrman, "Foreign Associates and Their Fi- nancing," United States Private and Government Investment Abroad (Edited by RaymondP]Mikesell)(Eugene, Oregon: University of Oregon Books, 1962), p. 88. 4John G. McLean, "Financing Overseas Expansion," Harvard Business Review, (March-April 1963), pp. 53—65. 122 there can be no doubt that the ultimate purpose of a foreign operation must be profit.5 Stonehill's study of foreign investment in Norway indicates that in about one-half of the cases "a reduction in the cost-of—goods sold" was the general goal for invest- ment. The strategic considerations (such as tariff or other import restrictions) and rate of profit were men- tioned respectively by one-fourth and one-fifth of the cases. His final conclusion was that the cost-of—goods sold by the investing firms, strategic considerations and profits in the Norwegian enterprises were really subsets of an overall goal of profit for the investor.6 Brash's extensive study of American investment in Australian industries indicates that "by far the most im- portant single reason given for the decision to invest was to take the advantage of the expected growth of the Austra- lian market." Besides this, the tariff barriers and import- restrictions were also mentioned as important 7 motives for investment. In the National Industrial 5Baldhard G. Falk, "Management Requirements of Foreign Operations," Management International, Vol. 6 (1963). pp. 51-52. 6Arthur Stonehill, Foreign Ownership in Norwegian Enterprises, (Oslo: Central Bureau of Statistics of Nor- 7Donald T. Brash, American Investment in Australian Industry, (Cambridge, Mass.: Harvard University Press; 1966) PP- ' 6. 123 Conference Board study of U.S. production abroad and the balance of payment, Judd Polk and others conclude that the investment decisions are made in response to competitive necessities that affect the entire earning position of their operation abroad ". . . while profit is correctly seen as the motivation of investment, few instances were encountered where a company executive felt that further investment could cease or to be materially slowed down without prejudice to the entire earning position."8 Thus the study points out that the marketing strategy was the dominant element in the investment decision. The review of these studies indicates that the main motives of the corporations investing in foreign countries are profit-oriented. These various motives are related either to cost considerations (i.e., reduction of cost-of-goods sold, availability of raw materials, tariff barriers, lower labor costs, transportation cost, etc.) or to revenue considerations (i.e., good market potential, expected growth of the economy, etc.). To find out the View of U.S. corporations regarding their motives of in- vesting in India, the questionnaire survey indicates the following objectives. 8Judd Polk and others, U.S. Production and the Balance of Pa ents, (New York: National Industrial Conference Board, Inc., 1966) pp. 35-36. 124 Objectives of Investing in India The response of the U.S. parent corporations re- garding their objectives of original investment in India (Question 1 of Appendix 1) is given in Table 5:1. Table 5:1.--Objectives of original investment in India. Number of Companies 1. Expectation of profit 13 2. Taking advantage of future growth of 10 Indian economy 3. Expansion of market for their products 7 4. Lower cost of production 2 5. Tariff or other import restrictions 2 6. Supply of raw materials - 7. Any other (please specify) ,g: Total 34a a . . . l4 U.S. corporations surveyed by questionnaire responded but several mentioned more than one reason for the investment in India. The response of U.S. corporations indicates that the expectation of profit was the main objective of origi- nal investment in India. However, taking advantage of future growth of Indian economy and expansion of market for the products were mentioned as two important sub- objectives for original investment in India. The lower 125 cost of production and tariff or import restrictions in India were also pointed out as the objectives for invest- ing in India but these were not the common motives for attracting these U.S. corporations in India. Not a single corporation pointed out the supply of raw material as the reason for starting investment project in India. It may be emphasized that the objectives of taking advantage of future growth of Indian economy, expansion of production, lower cost of production and tariff or import restriction are closely related with the main objective of original investment, i.e., expectation of profit. When the objective of the U.S. corporations going abroad was asked, during the course of personal interviews, the profit motive was usually clearly mentioned. Many of them (firms) also emphasized the better market opportunity for their products in the expanding Indian economy. But these executives pointed out that their corporations were interested not in short run profits, but in the long-run profit objective. If the demand for their products was increasing in India, the parent corporations professed to be not overly concerned about the near-term rate of return on their investment. filo ‘ AOL P‘i 1‘ Q \G t .1 AIIV ‘1‘ 126 PART II Capital BudgetingTheory and International Investment The main purpose of describing the capital budget- ing approach in the context of international business in- vestment is, not to test the applicability of this approach in the context of U.S. corporations' investment in India,9 but to provide a general idea regarding the techniques and the practices followed by the U.S. corporations for evalu- ating their investment decisions in the international field. This part, based on questionnaire survey personal interviews, covered some aspects, such as who makes the various types of decisions, what techniques are used for evaluation, what factors are considered, etc. During the course of personal interviews, the basic processes of making foreign investment decisions was asked. The narrations of the eleven executives in eight U.S. cor- porations10 point out a general pattern followed by the 9Hardly any study has been conducted regarding this aspect of the problem. One author has described the situation in the following words. ". . . No organized ef- ford has even been made successfully to extend the scope and application of the capital budgeting theory to the in- ternational field. . . ." (J. R. Bugnion, "Capital Budget- ing and International Corporation," The Quarterly Journal of AIESEC International, Vol. I, No. 5, (Geneva, Switzer- Iand) November,’I965, p. 31. 10Refer to Chapter II, p.83 127 U.S. corporations. Information regarding the various as- pects of the capital budgeting approach was also collected with the help of the questionnaire survey. A brief des- cription of the process of evaluating foreign investment decisions is presented here. The process is described in the context of their investment in India. However, the same process may not be followed by each corporation and may vary depending upon the financial resources of the corporations, their experience of working in foreign coun- tries, nature of their business, attitudes of the tOp management, etc. To explore the Opportunity and the possibility of investing in a foreign country, U.S. corporations typically conduct a broad survey of the economic, political and social environments of the foreign countries. The various government policies and regulations affecting the foreign investment are studied carefully. On the basis of such a survey, the corporations try to evaluate the investment climate and form a broad opinion about the opportunities and the various obstacles presented in the foreign country. If corporation has a favorable attitude, then it proceeds to conduct a detailed survey of the marketing and manu- facturing possibilities of their products. This involves the estimates of the possible demand for their products, the competition in the particular product market, the cost of producing the goods, etc. These estimates are prepared 128 from the short and long term point of views. Then the corporation examines the financial aSpects of the project. At this stage, the corporation also decides the nature of ownership, the possible Indian partner to be included in the project, size of units, area of country, product lines, trade channels, etc. Once this detailed analysis is evalu— ated, a decision is made regarding the possibility of starting the project in India; and the U.S. corporation, as the case may be, either talks to the potential Indian partner, soliciting his collaboration, or proceeds to nego- tiate with the Government of India. For evaluating the specific capital expenditure decisions, the U.S. corporations utilize various quantita- tive and qualitative techniques. In evaluating various as- pects of the investment, top priority is given to the sub- jective evaluation of the project. The personal experience and the observation of the top executives of the corpora- tion about India, their business experience in other developing countries and the suggestions of other foreign investors in India greatly influence the foreign investment decisions of the U.S. corporations. While analyzing the technical aspect, the U.S. corporations examine the expected rate of return, both from short and long term vieWpoint, on the investment. They try to develop a sort of trade-off between the ex- pected rate of return and the growth and expansion of their 129 products' market. In the short run the corporations empha- size the development of market but in the long-run the corporations expect that their subsidiaries should be able to earn at a greater rate than the domestic applica- tions (parent's rate of return would indicate this with given allowance for risks). The final decisions for the investment in foreign country is affected by the internal factors of the parent corporation and the external factors of the foreign coun- try. Judd Polk and others have pointed out that"the com- ponents of the company system [U.S. corporations] coming from within and the environmental factors coming from out- side converge on management in the formulation of inter- national investment decisions . . . executives mutually consider the possibilities through objective analysis but they envitably inject subjective opinion and feeling?11 Some aSpects of the above process are discussed, in brief, under the following headings. Who Makes the Final Decision? The final decision regarding the major capital eXpenditures aarger than 5% of equity investment), choos- ing the sources of financing of capital expenditures and employment of top executives of subsidiaries are mainly llJudd Polk and others, op. cit., p. 55. 130 taken by the parent corporation.12 In some cases, even the minor capital expenditure decisions are under the jurisdiction of the parent corporation. In two cases, it was pointed out that their Indian subsidiaries also shared the responsibility for deciding the nature of the major capital expenditures. In general, though, the finan- cial aspects of the subsidiaries' Operations appear to be under control of the parent corporation.13 The production planning, marketing planning, purchase of raw materials and day-to-day operations of the subsidiary are the main reSponsibility of the subsidiary and the parent corpora- tion does not usually become involved in these affairs. The details of this (Question 2 of Appendix 1) are given in Table 5:2. Choosing Among Alternative Proposals As regards the detailed economic surveys of the most likely investment opportunities, the response of the parent corporations (Question No. 3 of Appendix 1) indi— cates that nine of the U.S. corporations conduct such 12Even where U.S. ownership is nominal (10% to 25%), the parent corporations have greater influence on major decisions. 13Similar findings were reported by Jean-Luc Rocour, "Management of European Subsidiaries in the United States," Management International, I, (1966) pp. 22-23. 131 Table 5:2.--Authority for making decisions for different policies. Parent Indian Corporation Subsidiary Total a) Major capital expenditures (larger than 5% of the 14 2 16 equity investment) b) Minor capital expenditures (below 5% of the equity 7 7 l4 investment) c) Choosing sources of financ- ing of capital 9 5 14 expenditure d) Production planning 1 13 14 e) Marketing planning - 14 14 f) Purchase of raw materials, equipment, etc. - l4 14 g) Day—to-day Operations - l4 14 h) Employment of top 9 5 14 executives aTwo corporations mentioned that the decision is made jointly by the parent corporations and subsidiaries. Thus in none of the sample firms does the management of the subsidiary act unilaterally. surveys whereas the other five U.S. corporationsl4 do not conduct such surveys. l4These corporations rely on personal impression, prior knowledge and other sources of information. 132 For the evaluation of foreign investment alterna- tives, the U.S. corporations apply both formalized quanti- tative models and subjective evaluation, though their emphasis on the different techniques differs from corpora- tion to corporation. More than one-half of the U.S. parents pointed out that they placed great emphasis on formalized quantitative models, while two-thirds Of the same U.S. corporations also mentioned that they utilized subjective evaluation (Question 4 of Appendix 1). The details are given in Table 5:3. Table 5:3.—-Techniques used for evaluation of alternative proposals. Emphasis Given Very Much Somewhat None No. of % of No. of % of No. of % of Comp.a Total Comp.a Total Comp.a Total a) Formalized Quantitative Models 7 58 4 33 - - b) Subjective _ _ Evaluation _: 42 _E 67 ,__ ___ Totalb 12_ 100 12 100 ‘g: _: a . Comp. = Companies. Two corporations did not mention any techniques. 133 Among the U.S. corporations using the formalized quantitative models for the evaluation of alternative pro- posals, the payback and the internal rate of return methods are more prevalent than the net present value method and the average rate of return on book value. A few other methods were also reported (Question 4(A) of Appendix 1). The details are given in Table 5:4. Table 5:4.--Forma1ized quantitative models used by U.S. corporations. Number of Companies a) Payback method 8 b) Internal rate of return 6 c) Net present value method 4 d) Average rate of return on book value 3 e) Any other method _4 Totala 5 aMany of the corporations responded that they fol- low more than one method. Among these methods, the payback method is the most pOpular method of capital budgeting. Out of the four- teen U.S. corporations, eight corporations followed this 15 technique. But many corporations supplemented this 15The payback method is also a pOpular method used by the U.S. corporations for evaluating the capital 134 method with other methods. Variables Affecting the Risks of Foreign Investment DecisiOns There are a number of environmental variables which are considered to be important for the foreign investment decisions. Some of these variables are of major importance while others are considered as minor variables in affecting the foreign investment decisions. Among the various vari- ables, present or absence of limitations on remittance of profit, stability of exchange rate, convertibility of cur— rency, repatriation of capital, political stability and rapid economic growth of the foreign country are considered to be of paramount importance and the parent corporations placed major emphasis on these variables. Six of the fourteen give major emphasis to the rate of inflation and tax considerations as an important but not of primary significance. The encouragement pro- vided by the U.S. Government for foreign investment is not considered at all as an important variable influencing the foreign investment decision of the U.S. corporations. Amont these variables, none (except encouragement provided budgeting decisions for the domestic investment. A survey made by the Machinery and Allied Products Institute indi- cates that 60% of the survey-firms (U.S. corporations) use the payback period. (J. Fred Weston and Eugene F. Brigham, Managerial Finance, Third Edition, (New York: Holt, Rine- hart and Winston, 1969) p. 180. 135 by the U.S. Government) is treated as insignificant in making the foreign investment decisions (Question No. 8 of Appendix 1). The details are given in Table 5:5. Table S:5.—-Variables affecting foreign investment decisions. Emphasis Given by Number of Companies Major Minor None Total 1) Repatriation of capital 11 3 - 14 2) Convertibility of currency l3 1 - 14 3) Stability of exchange rate 13 1 - 14 4) Remittance of profit, etc. 14 - - l4 5) Foreign tax considerations 6 8 - 14 6) Inflation 6 8 - l4 7) Political stability 12 2 - 14 8) Rapid economic growth 9 5 - 14 9) Encouragement by U.S. _ 10 4 14 Government 10) Any other - - - - Alternative Methods of Treating Risks While evaluating the investment possibilities for foreign countries, twelve of the fourteen U.S. corporations indicated that they consider risk element explicitly in their decision making process (Question 5 of Appendix 1). Most of these 12 corporations use more than one technique 136 for incorporating the risk aspects. About one-half of the U.S. corporations vary the required rate of return on investment. Some corporations use shorter payback period and higher discounting rate but these two methods are not as popular as the varying rate of return on in- vestment. In some cases, the U.S. corporations do not use the formalized techniques (Question No. 5(i) of Appendix 1). The details are given in Table 5:6. Table 5:6.--Techniques used to incorporate risk in foreign investment. Number of Percentage Companies of Total A) Formalized Techniques 20 91 l. Varying the required rate of return on investment 10 45 2. Varying the payback period 3 14 3. Higher discounting rate 2 9 4. Sensitivity analysis 2 9 5. Adjusting the cost of capital in present value method 1 4 6. Simulation by model _2_ _9 B) Subjective Evaluation _2 __9 Totala 2 100 aMany corporations used more than one technique. 137 Cost of Capital In the evaluation of capital budgeting decisions, the cost of capital is considered as important variable. Some U.S. corporations use different cost of capital for their domestic and foreign investments. The response of the U.S. companies (Question No. 6 of Appendix 1) indi- cates that about two-thirds of these (nine of the fourteen) corporations use the same cost of capital for the domestic and foreign investment purposes. The other five firms do, however, make this distinction and use separate cost of 16 These five capital for domestic and foreign investment. apply various techniques for adjusting the cost of capital for foreign investment decision purposes; as detailed in Table 5:7. Table 5:7 indicates that no single method of cal- culating the cost of capital for the foreign investment decision is especially popular among the U.S. corporations in this sample and each uses different technique to adjust it. l6n . . In a recent survey of ninety-two U.S. companies with substantial direct investment, thirty-nine of them said that, in making up their capital budgets, they made no distinction between foreign and domestic investment a1- ternatives." Sanford Rose, "The Rewarding Strategies of Multinationalism," Fortune, Vol. LXXXVIII, No. 4, September 15, 1968, p. 101. 138 Table 5:7.--Adjustment of cost of capital for foreign investment. Number of Companies 1. Varying cost of capital subjectively 1 2. Use parent corporation's cost of capital 1 3. Use prime interest rate of U.S.A. 1 4. Use cost of capital of foreign subsidiary 2 5. Any other 1 Totala 6 aOne corporation reported two methods. PART III Investment Policy The main purpose of this part of the chapter is to test the following hypothesis: The investment policy of the U.S. subsidiaries is similar to that of their parent corporations. (Ho) The alternative hypothesis is that the investment policy of the U.S. subsidiaries is materially dif- ferent from their parent corporations. (H1) The criterion for testing the above hypothesis is to compare components and forms of investments, finan- cial structure, and dividend payout ratios of the U.S. subsidiaries with their parent corporations. These com- parisons will be made, not on the individual basis, but 139 on an aggregate basis and also on the basis of nature of industry, age, ownership, management and size of the U.S. subsidiaries. In each comparison, the parent and its sub- sidiary are paired. The comparison is made on the basis of ratio scale. It is widely assumed that when the U.S. corpora- tions take decisions to invest in the foreign country, they examine the various aspects of the investment projects. Among these aspects, the nature of their investment and the sources of financing are of great significance. Since the major capital expenditures and the sources of financing are mainly governed by the parent corporations, it may be hypothesized that their subsidiaries will follow similar investment patterns, and financial structure as that of their parent corporations. And if they follow similar in- vestment patterns and financial structure, it will be re- flected on the financial statements of their subsidiaries. Lindsay and Sametz have pointed out that "Every time manage- ment makes its decisions to undertake a new investment project, it is at the same time making a decision as to the appropriate capital structure the firm should have."17 Thus the investment pattern and the financial structure of 17J. Robert Lindsay and Arnold W. Sametz, Finan- cial Management, Revised Edition, (Homewood, IllinOis: RiChard D. Irwin, Inc., 1967) p. 319. 140 the subsidiaries would reflect all the previous decisions made by the parent corporations. On the other hand, it is also argued that, although the investment and financial policies of the subsidiaries are mainly under the jurisdiction of the parent corpora— tions, the subsidiaries operating in foreign countries try to adjust their investment and financial policies to suit the foreign environment. In other words, economic, politi- cal and other situations may influence the investment and financial policies. Moreover, nature of industry, age, ownership, management and size of the subsidiaries may in— fluence investment pattern, and financial structure of the subsidiaries. The main hypothesis mentioned above has been divided into the following three sub-hypotheses: (1) The ratio of investment in the asset composition of the U.S. subsidiaries is the same as that of their parent corporations. (Ho) The alternative hypothesis is that the ratio of investment in the asset composition of the U.S. subsidiaries is dif— ferent from their parent corporations. (H1) (2) The financial structure of the U.S. subsidiaries is similar to their parent corporations (Ho). The alternative hypothesis is that financial structure of the U.S. subsidiaries is different from their parent corporations. (Hi) 141 (3) The dividend payout ratio of the U.S. subsidiaries is equal to their parent corporations (Ho). The alternative hypothesis is that the dividend pay— out ratio of the U.S. subsidiaries is not equal to their parent corporations (Hi). The above three sub-hypotheses have been discussed under the captions 'Investment in Assets,’ 'Financial Struc- ture,‘ and 'Dividend policy' respectively. The discussion in each part is based on the price level adjusted financial statements of 27 participating U.S. subsidiaries and the unadjusted financial statements of their parent corporations.18 Investment in Assets It is hypothesized that the investment of the U.S. subsidiaries in the various major asset types is similar to their parent corporations. If the subsidiaries follow the same general pattern of investment policy as that of their parent corporations, the null hypothesis will be ac- cepted and the alternative hypothesis will be rejected. The term 'investment' refers to the amount of the capital invested in the different assets of the firm. It incorporates the total current assets, fixed assets and other assets and is reflected on the asset side of the balance sheet. While analyzing the investment projects, 18For details, refer to Chapter IV. 142 the financial experts in the academic world place greater emphasis on the permanent nature of the assets (such as investment in plant and machinery) and ignore the invest- ment in current assets. However, any analysis without current assets would be misleading because cash, market- able securities, accounts receivable and inventory also represent investment and the same capital budgeting theory is applicable in these types of current assets also.19 Their composition and pattern in the case of each firm also reflects the previous decisions taken by the management. Overall Comparison.--Table 5:8 represents a com- parative picture of the investment in the different assets by the subsidiaries and the parent corporations for the years 1963-67. The table indicates that the U.S. subsidi- aries invested approximately one-half (48%) of their total resources in net fixed asset whereas their parent corpora- 'tions invested about two-fifths (40%) in this asset. On 'the other hand, the parent corporations had more than one- 1131f (53%) of their total assets in the form of total cur— rent assets as against about two-fifths (46%) by their Eiubsidiaries. Moreover, the investment of subsidiaries in tflie net fixed assets had always been greater than their Euarent corporations in each year. The opposite situation F 19Seymour Friedland, The Economics of Corporate inance, (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1966) pp. 52-144. 143 eo.eoa oo.ooa oe.eoa oe.oea ee.eoa eo.eea mumeeemssm mummmm Hmuoa oe.ss mo.me mo.mv mm.ss me.ms mm.sv museeemssm mm.mm mm.oe so.mm mm.mm k~.mm NH.oe assume mfiwmmfl UQXHh em.e mm.e me.m mk.m ee.e ss.m sumeeemnsm em.» mm.e me.e Hm.s os.e mm.e paused mummmm Hmfiuo mm.ms eo.me sm.es mo.se sm.we km.mv sumeeemnsm mummmm #COHHDU HM¥OB He.m mm.e Hm.e Hm.m mk.m Hm.H assessmssm mm.o ee.o He.e oe.o mm.o mm.o assume m#wmmm uCTHHDU Hmfivo sm.m~ Ne.em mm.mm me.mm mo.em sm.mm sumsesmssm sm.mm mm.e~ me.e~ mm.m~ mm.mm HH.m~ usmumd mwfiHO#G®>GH. sm.~a me.ma mm.HH av.mH mm.HH om.HH mumeeemssm em.mH me.mH os.mH mm.mH ms.ma mm.sa usmumd mHQm>Hm0®H mflCDOOO¢ Hm.m me.m ms.m eH.e mm.m ~m.s suesesmssm NH.OH mm.» we.m HH.HH me.HH me.HH assume mmfluflnfiowm OHQM#TXHME @Gw SmMU wwmmwmw :sema mead mesa seas mesa A.mmmucwoumm cHV .Abwma Imwmav mcofluMHomHoo ucmumm Hamsu new mmflumwwflmnzm mo cumuumu pamfiumm>cHll.mum magma 144 is found in the case of current assets. The investment of the parent corporations in the 'other' assets is slightly higher than their subsidiaries. Out of the total current assets, the investment of subsidiaries in inventories was more than one-half as against two-fifths by the parent corporations. More than one-third of the total current assets of the parent cor- poration was in the form of accounts receivable whereas this asset was slightly more than one-fourth in the case of the subsidiaries. The parent corporations kept a higher proportion of their total investment in the form of cash and marketable securities than their subsidiaries. From the above aggregate level analysis, it is evident that the subsidiaries had relatively more invest- ment in net fixed assets and inventories than their parent corporations and, of course, the parent corporations had invested relatively more in cash and marketable securities, and accounts receivables than their Indian subsidiaries. The difference is great enough to conclude that in general the U.S. subsidiaries did not follow an investment pattern sindlar to that of their parent corporations. The main :reason for the higher percentage of investment in fixed éissets by the subsidiaries may be attributed to the high :initial investment in plant and machinery and the lesser diepreciation write—off on the fairly new fixed assets. bdoreover, due to the shortage of foreign exchange and 145 constant fear of import restrictions, the U.S. subsidiaries might have tried to install excess plant and machinery. This situation has also affected the decisions of the sub- sidiaries to accumulate raw materials and build inventories. The economic uncertainties and difficulties in procuring raw materials might have induced the subsidiaries to build large buffer stocks for any emergency. The lower percentage of investment in accounts re- ceivable of the U.S. subsidiaries may be due to the under- developed nature of credit system and facilities and stag— nation in the Indian economy during these years resulting in the lower demand for the products. Moreover, the in- creasing inflationary pressure on the economy might have induced to the subsidiaries to give less credit to their customers. As against this, the parent corporations did not exPerience economic stagnation, shortage of foreign ex- change and import restrictions. Moreover, the parent corporations are fairly old and their fixed assets have been depreciated more than their Indian subsidiaries. Due ‘to better technological and transport facilities, the U.S. Chorporations did not experience the severe problems of Elrocuring raw materials, plant and machinery. Group-Wise Comparison.--A further analysis of the Eissets composition on the basis of nature of industry, age, Gunnership, management and size of the U.S. subsidiaries 146 and their parent corporations points out some different features. Industry-Wise Comparison.--Table 5:9 shows that the parent corporations have a greater percentage of in- vestment in total current assets than their subsidiaries operating in transport, machinery, metal and metal products and 'other' industries. On the other hand, the U.S. sub- sidiaries Operating in petroleum industry have one-half of their investment in total current assets as against only one-third by their parent corporations. The investment of the parent corporations and their subsidiaries operating in the chemical and allied industry in total current assets is more or less the same. The investment in the net fixed assets of the parent corporations operating in the petroleum and chemi- cal industries is greater than their subsidiaries. On the other hand, the subsidiaries operating in other industries have more investment in net fixed assets than their parent corporations. The U.S. subsidiaries operating in transport, metal and metal products and electrical industries have smaller investment in inventories than their parent cor- porations. Moreover, the subsidiaries operating in machinery and transport had more than one-fourth of their investment in inventories as against less than one-seventh by the subsidiaries engaged in metal and metal products 147 bbhbe .bbhpr pp.ppn pp.opH pn.pr pp.nnH mummmw Hmuoe h~.¢m mw.mm on.mm hm.mm mm.mm mm.om mummmm Omxflm nm.m m>.h mm.m vm.v oo.m mH.m mpmmmm Hmnuo .|.|I| ..|I.|| Il.||. .|.| I l mummmm E .mblbml Em! E HE: Eb! pcmuuso Hmuoe mv.¢ ma.o vm.m hm.o mm.o hv.H mummmm unmanso Hmnpo mm.ma mm.ma mm.mm mw.nm mm.mm mv.om mwfiuoucm>cH ov.m oa.ma mm.HH mm.~m mH.m hw.mm manm>flmomu mucsooo¢ av.H mm.m mm.~ nm.n vm.m mm.m mmwufludomm manmumxnme cam ammo humaoflmnnm ucmumm humfloflmnsm ucmnmm Mudflcflmnsm ucwnmm mus mus vuc asymmummmommuwz wumcflnomz unmamflsqm uuommcmus A.mmmucmoumm aHV .Anmlmoma mo mmmum>mv muumsccfi mo manna map so mcoHumuomuoo ucmumm tam mmfiumflcflmnsm mo :umuumm ucwsumm>cHll.mum OHQMB 148 oo.ooa oo.ooH oo.ooa oo.ooa oo.ooa oo.ooa oo.ooa oo.ooa mummmm HMDOB mmqmwl se.mm ee.em me.me em.mm mmummu. mmqwmu mmqmmn 6006mm sexes mm.o OH.HH vo.m Nh.m hm.ma mm.m mm.mH om.v mummmm Hmnuo Eu ERR. ELF E E E E E ssmfimwmwmg NN.H hm.o mm.m mH.o nn.m om.m mH.H mm.o mummmm ucmuuso Hmcuo no.ma an.m oo.mm vm.am wm.mm mm.ma mm.H om.h mmfluouco>sH mv.Hm mm.aa mm.m mm.Hm nm.va vv.ma mv.m mm.na manm>flmoou mucsooo< om.v mm.> vm.m ma.n mm.m mm.ma mn.o mm.m mOHuHHOOOm OHQMDOmeE cam ammo mumwpflm ucmumm mumflpflm ucmnmm mumflcflm pcwumm wumflcflm ucwumm Insm IQSm 135m Ibdm mus bu: mug and Esmaonumm mumnuo cmflaad HMOHHpOOHm paw HOOHEmzo Asmsseusoovuu.mum waste 149 and petroleum industries. The share of accounts receiv- able of the parent corporation is higher than their subsidiaries in all the industrial groups except petroleum industry. Age-Wise Comparison.--Table 5:10 indicates that the older subsidiaries started prior to 1956 tend to have more investment in current assets than their parent corporations. On the other hand, the new subsidiaries have larger invest- ment in net fixed assets than their parent corporations. This is mainly due to the fact that less depreciation has been written-off in the case of new subsidiaries. The subsidiaries in all the age groups have a greater proportional investment in inventories than their parent corporations. The U.S. subsidiaries started during 1951- 1956 have larger investment in accounts receivable than their parent corporations. The U.S. subsidiaries have less cash and marketable securities than their parent corpora- tions in all age groups. Ownership;Wise Comparison.--Tab1e 5:11 indicates that the subsidiaries with more than 75% U.S. ownership have more investment in total current assets and less in- vestment in net fixed assets than their parent corporations. The U.S. subsidiaries in other ownership groups, have less investment in total current assets and more in net fixed assets than their parent corporations. 150 oo.ooa oo.ooa oo.ooa oo.ooa oo.OOH oo.ooa oo.ooa oo.ooa mummmm Hmuoa mv.Hv mm.m~ om.mm mm.Hv v0.0m em.mv on.mm nm.av mummmm cmxflm mv.w ha.h oa.m mm.m mh.v wm.> om.m mh.b mummmm umruo No.8m om.ww vo.mm mo.am mm.mm om.om ow.Hm Ho.Hm mummmm ucmuuso Hmuoe mv.o om.H mm.o vv.~ mm.n mh.o mm.m mm.o mumnuo mm.om mm.mm om.mm mm.am mm.mm mm.vm ma.m~ hm.HN mmfluoucm>cH hm.va mm.~m Hm.n ma.ma mn.ma mm.wa mo.ma mH.mH manm>wmomu muddoood no.m em.oa mm.m oo.m mv.v mm.> mm.v ov.m mmfluflusomm magnumxume can Sumo kHMflOflm ucmumm huwflwfim ucoumm humaoflm ucmumm humficflm ucmumm Imam Imam Indm 135m NH": mama Hmlbmma mmlamma omma OHOMOm A.wmmucmonmm GHV .Ahwlmmma mo mmwum>mv mom mo mammn map so mcoflumuomuoo ucwumm menu was mOHMMHOHmQSm mo cumuumm unmaumm>cHll.oaum wabme 151 .mumflcflmbsm n m “pamumm H mm C I O O O O O O 0 O mgmmmm OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH Hmuoe ma.mm mv.mm mo.mv mm.mm mv.ve mH.om HH.¢O mm.mv ma.mm mm.hm mummmm Omxflm Om.m no.0 O0.0 hm.v w0.0H O0.0 OH.N mm.m HO.m mm.n mammmm umnuo mbmmmm mm.mw Ov.hm OH.mO OH.Om Hm.mv OH.mm Ob.mm Ha.mv Ha.av mm.mm pawn nuso Hmuoe H0.0 m0.0 mm.O Hm.m mm.m ON.H mO.m mm.O OO.H Hm.O mumruo mm.mm mm.mm OH.ON mm.vm Ov.ma nm.mm mm.na mm.ma ON.ON mo.v~ mmflnoucm>cH vb.OH n0.0N OH.NH mm.OH Hm.ma H0.0N N0.0 mm.ma mm.OH ON.HN mabm>flmomu mucsoood mm.H mH.O Ov.m hm.m mm.m mn.m ma.m mO.> H>.N N0.0 mmfluausomm magnumxume Odd nmmu m m m m m m m m mm mm Qua mug VHC mug mug m>on¢ was won wmblmam womlwav wovlwom meIwOH A.wmmucwoumm cHV .Ahmlmoma Mo mmmum>mv magnumczo mo mflmmn opp co mcoflumuomuoo ucmumm Ocm mmflumwoflmnsm mo cumupmm ucwEumO>cHll.HH"m magma 152 Management-Wise Comparison.--Table 5:12 shows that 50% U.S. managed subsidiaries have larger total cur- rent assets than their parent corporations whereas in other management groups the subsidiaries have smaller total current assets than their parent corporations. The subsidiaries have more investment in net fixed assets than their parent corporations in all the management groups except 50% U.S. managed subsidiaries. The wholly U.S.-managed subsidiaries have more investment in accounts receivable than their parent cor- porations. On the other hand, the majority-managed U.S. subsidiaries have less investment in inventories than their parent corporations. In others, the opposite situa- tion is found. Size-Wise Comparison.--Tables 5:13(A), 5:13(B), and 5:13(C) show the investment pattern of the subsidiaries in the different size groups based on total assets, total sales and total net worth respectively. Table 5:13(A) indicates that in all the size groups, total current as- sets of the subsidiaries form smaller percentage of total assets than their parent corporations. On the other hand, the subsidiaries in all the size groups have more invest- ment in net fixed assets than their parent corporations but.the smallest subsidiaries have relative more investment in net fixed assets than their parent corporations. 153 .wumHOHmnsw n m «Hammad H mm 0 O O O O O O O O O mummmm OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH Hmuoe O0.0v NN.mm mm.mm OO.vv mm.mm OO.vv mm.nv hm.vm mm.nm mo.nm mummmm OOme Om.h mO.m Hm.m om.m mm.m mm.h Hm.m h~.m mm.m OH.v mummmm nonpo mummmm ON.Hm mn.mm vm.vm om.he OH.Nm vo.mv mo.nv Om.mm mm.mm Om.mm pawn IHOO Hmpoe mm.m em.O OH.H mv.O Om.h OH.O O~.v pH.v O0.0 m0.0 mumsuo Oh.mm Hm.mm Om.mm «0.0m hN.Om Ov.mm >>.vm Nv.mm mH.mm mm.mm mmHuoucm>cH OO.¢H mm.mH mm.m O0.0H Om.OH O0.0H v>.HH mH.Hm mO.wm OO.HN mem>HOomu mucsoood vm.O mo.m om.m mm.m nO.m mn.m O~.O vm.m OO.H ov.n mOHuHHDOOm OHbmumxumfi was cmmu m m m m m m m m mm mm NHC mug finch mug MHC mnouomHHo mnouomHHo muouomuHo muouomHHo muopomuHo smHesH HHs .m.O HuHuost .m.O mom .m.O suHuonz .m.O HH< H.008chonmm GHV .HOOImOOH mo mmmum>mv ucmawmmsme mo mHmmn on“ so msOHumuomHoo unmade can mOHHMHOHmQOm mo cumuuma ucmfiumm>cHll.mHum mHnma 154 .hn6HOHmnsm u m unsound H mm 0 O O O O O O O O O mgmmmm OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH Hmpoa mm.hm vw.m¢ mm.mv «O.Hv Om.~O mm.mv mm.m~ Om.m~ vm.mv mm.mm mummmm Omme mH.N mo.n mb.n mm.m O0.0 mm.m OO.vH mm.~ O0.0 H0.0 mummmm umcuo mummmm mm.mm mm.n¢ m>.mv mO.mv vO.Hm mh.mv mm.mm mn.Ob ov.hv v~.mm ucmu undo HmuOB Hm.H NN.H O0.0 vm.o NO.m mm.m N0.0 mm.O mv.O vm.O mumbuo O0.0H mm.mH mn.mm mv.Hm Om.OH mm.mH mv.me OO.HO H0.0N m0.0m mOHuoucO>sH NN.OH mn.mH Ov.HH m0.0H mO.m Oh.mH mm.OH OO.N~ Hm.mH OO.HN OHbm>Hmomu, mucdoood OO.m mm.> mm.v hv.m NO.m mm.m ON.O O0.0 mh.m mw.OH mOHuHHOOOm OHbmumxumE tam ammo m m m m m m m m mm mm wUG FHG mHG NHG Fug O>Obm N0.0Nm swap om.mw can» ON.ww swap OO.mw can mm.omw mmmH can Om.mw mmmH can ON.vm mmmH cam OO.mw can» mmOH “.mmmucmoumm cHO .AhmumOmH MO mommm>mv ONHm HmHMHHOU mo mcoHHHHE :HO mummmm Hmuou Ho mHmmn on» so chHumuomHOO pcmumm Usw mOHHMHOHmQOm mo cumuumm ucmfiumO>GHII.H HO.mm mm.~m OO.Hm muommm Omme mm.w mm.h mm.w hm.m m>.> mv.m mm.mH om.v mm.v mm.n mummmm Hmsuo mummmm mm.mv hm.Om v>.mv mm.vm Oh.Om Hm.Hm mv.m Om.m~ OO.Nv O>.HO pawn IHOO Hmuoa m~.m om.m wm.m I m>.O NH.H OH.H mm.O om.O mm.O mumcuo mO.vN nh.ON mN.ON mm.hm vm.mm mm.HN mm.H ON.> mo.mm mH.Om mOHuouco>cH OO.¢H O0.0H HH.m nm.om Nv.OH No.4H mv.m ON.OH mm.m Om.mm OHOHSHOOO.H mussoood mm.m mm.m OO.N v~.n v0.0H mm.mH O0.0 mm.m mm.m Ov.m mOHanOOOm memumxumE was ammo m m m m m m m m mm mm HHuc en: OH: H": bus m>onm m~.mm can» mO.mm can» mO.Hw cmsu mm.Ow Ocm mm.mw mmOH can OO.mw mmOH was mO.Hw mmmH Ocm mm.Om can» mmmH H.0mmucmonmm :HO .Ahmlmme MO mmmnm>mv muHm HmHmHHOO mo mcoHHHHE GHO mOHmm Hmuou mo memn may no mcoHpmuomuoo ucmuwm can mOHHmHOHmQOm mo cumuumm ucmEumO>cHll.HmOmHum OHQMB 156 .hHMHOHmQOm m unsound H mm C O O O O O O O O O mummmm OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH OO OOH Hmuoe Om.hm vw.mv mv.mv OO.vv om.mv mm.OH Om.mv mH.mm mm.om m0.0N mummmm Omme mH.m mo.h hm.h mm.m HO.HH Om.m mm.m Om.m mm.MH Nv.o mummmm Hmnpo mummmm mm.mm mm.hv mm.vv OO.>¢ mm.mv mb.m> Oh.>¢ Om.mm OH.Om mm.mw pawn Iuso Hmuoa OO.H NN.H OO.¢ Om.~ OH. I OO.H O0.0 I mH.H muscuo mm.mH mm.mH Hv.mm OH.OH mm.mm ON.mm NH.mm NH.Hm O0.0N mm.om mmHuoucm>cH NN.OH mn.mH ON.OH N0.0H vm.m O0.0N H0.0H Om.Om O0.0H SO.HN manE/Hmom.H mucsoood vO.m mm.n O0.0 OO.m eO.H hm.w HO.H O0.0 O>.OH Hm.MH mOHuHusomm anmumxumE was nmmu m m m m m AH m m mm mm mug NHHS Nflfi VHS MUG m>onm mm.mw can» OO.Nw sway mO.Hm can» mm.ow can m~.mm mmOH can OO.Nw mmmH was mO.Hm mme can mm.ow :mnu mmmH A.Ommu:moumm :HO .HhmlmmmH mo wmmnm>mv ONHm HmumHHOO mo mOOHHHHE GHV suuo3 use Hmuou mo mHmmn ecu so msoHumuomnoo agenda was mmHHMHUHmQOm mo sumuumd ucmEumw>cHII.HuOmHum OHQOB 157 The smallest and the largest subsidiaries have less investment in inventories than their parent corpora- tions but in other groups the subsidiaries have larger in- ventories than their parent corporations. The investment in cash and marketable securities, and accounts receivable of the subsidiaries in all the size groups is smaller than their parent corporations. Tables 5:13(B) and 5:13(C) re- veal similar patterns of investment, as noticed in the case of Table 5:13(A). The comparison of the investment pattern of the parent corporations and their Indian subsidiaries on the basis of industry, age, ownership, management and size indicates the similarity and dissimilarity of their pat- tern. The analysis indicates that the general pattern of investment as emerged from the aggregate level analysis is also found in most of the group-wise comparisons. But in some cases, this pattern is not noticed. For instance, the aggregate level comparison indicates that the U.S. subsidiaries have smaller accounts receivables than their parent corporations but the subsidiaries operating in the petroleum industry have more investment in this item than their parent corporations. The majority-managed U.S. sub- sidiaries have less investment in inventories than their parent corporations. In the same way, the smallest and the largest-sized subsidiaries (based on total size of assets) have smaller inventories than their parent corporations. 158 On the basis of the group-wise comparison, it is hard to draw broad conclusions because there are not enough number of subsidiaries in each group. However, the above analysis indicates that the U.S. subsidiaries operating in India did not follow similar investment pattern as that of their parent corporations. Financial Structure It is hypothesized that the financial structure of the U.S. subsidiaries is similar to that of their parent corporations. This hypothesis is proposed to be tested by comparing the financial structure of the subsidiaries with their parent corporations. If the subsidiaries follow the same financial structure as that of their parent corpora- tions, the null hypothesis will be accepted and the alter— native hypothesis will be rejected. The term l'financial structure" incorporates cur- rent liabilities, long term debt, preferred stock, common stock, retained earnings, etc. It refers to the ”Liabili- ties and Stockholders' Equity" side of the balance sheet. The "financial structure" is different from that of the "capital structure" which is the permanent financing of the firm and includes long term debt, preferred stock and net worth. The main purpose of incorporating current liabilities (short-term borrowing) in the financial struc- ture is that this source constitutes an important source of financing; and given the great importance of the bank 159 loans and advances and the trade credit, it seems artificial to omit the short term borrowings from the capital structure of the firm. Moreover, these short term loans and advances are Often rolled forward year after year and take the form of medium-term loans and advances. Overall Comparison.--Table 5:14 presents the finan- cial structure of the subsidiaries and parent corporations for the years 1963—1967. Among the different sources of finance, the total debts (current and long term) were approximately one-half of the total sources of finance of the U.S. subsidiaries whereas this source provided one-third of the total finance of the parent corporations. The current liabilities alone were one-third of the total source of finance as against one-fifth in the case of the parent corporations. The U.S. subsidiaries raised approximately one- fifth of the total source of finance from the short term loans and advances whereas this source was insignificant for the parent corporations. Retained earnings accounted for more than one-half of the total finance of the parent corporations whereas this source provided less than one- sixth of the total finance of the subsidiaries. Preferred stock played an insignificant role as a source of capital in the case of both subsidiaries and the parent corporation. But the share of the parent cor- porations was greater than the subsidiaries. 160 Table 5:14.--Financia1 structure of subsidiaries and their parent corporations (1963-67). (In percentage.) 1963 1964 1965 Pa 85’ P s P 5 Accounts payable 7.43 8.37 7.65 8.64 8.06 8.65 Loans and advances 3.38 20.19 3.74 19.30 2.46 21.32 Provisions 4.81 7.28 5.51 7.79 6.69 5.58 Other current liabilities 1.90 0.16 1.59 0.32 2.72 0.59 Total current liabilities 17.52 36.00 18.49 36.05 19.93 36.15 Other liabilities 2.10 0.20 - 0.10 0.68 0.05 Long-term debts 11.75 12.48 14.45 14.44 12.87 16.15 Preferred stock 5.17 0.10 4.11 0.20 4.48 0.86 Common stock 11.39 38.74 10.66 35.79 10.25 31.85 Retained earnings 52.07 12.53 52.29 13.42 51.79 14.94 Total stockhold- ers' equity 68.63 51.36 67.06 49.41 66.52 47.65 Total liabilities and stockhold- 100.00 100.00 100.00 100.00 100.00 100.00 ers' equity 1966 1967 Avg. of 1963-67 P S P S P 8 Accounts payable 8.69 8.30 8.33 9.34 8.03 8.66 Loans and advances 4.34 18.63 5.19 17.46 3.82 19.38 Provisions 5.57 6.46 4.67 5.28 5.45 6.50 Other current liabilities 2.94 0.30 2.35 1.53 2.30 0.58 T°t81 ?“Fr?nt 21.54 33.79 20.54 33.61 19.60 35.12 liabilities -———-— -—-——- Other liabilities 1.33 0.80 1.26 0.21 1.08 0.27 Long-term debts 14.45 13.20 15.54 14.41 13.81 14.14 Preferred stock 3.08 1.46 2.83 1.65 3.93 0.85 Common stock 9.55 32.03 9.30 30.40 10.23 33.77 Retained earnings 50.05 18.72 50.53 19.72 51.35 15.85 T°ta1,5tocfh°1d' 62.68 56.21 62.66 51.77 65.51 51.27 ers equity -—————- Total liabilities and stOCkhold- 100.00 100.00 100.00 100.00 100.00 100.00 ers' equity a P = Parent; S = b Subsidiary. Provisions for taxations, dividend and contingencies. 161 Thus the participating subsidiaries, on the whole, showed a total debt-equity ratio of 0.95 which is greater than the total debt—equity ratio of 0.56 of their parent corporations. It indicates that the U.S. subsidiaries relied more on the short and long term debts for financing their operations than their parent corporations. But the debt-equity ratio did not increase beyond the limit pre- scribed by the Controller of Capital Issues. The parent corporations depended more on the equity financing--parti- cularly on the retained earnings. Retained earnings, on the whole, were not the major source of finance in the case of U.S. subsidiaries operating in India. Group-Wise Comparison.--From the above analysis it is evident that the average subsidiaries did not adopt the same financial structure as their parentL A further analy- sis Of the financial structure of the participating sub- sidiaries on the basis of nature of product, age, ownership, management and size of these subsidiaries would throw some more light on the comparison of the financial structure of the subsidiaries and their parent corporations. Industrijise Comparison.--Table 5:15 gives the details of the financial structure of the subsidiaries and their parent corporations in the different industrial classifications. It indicates that the total current liabilities of the U.S. subsidiaries engaged in all the industrial groups were greater than their parent corporations. 162 Table 5:15.--Financial structure of subsidiaries and their parent corporations on the basis of industry. (In percentage.) Transport Machinery Metal and Metal Products n=4 n=5 n=3 Pal sa P s P s Accounts payable 9.60 8.18 10.61 14.83 7.35 7.48 Loans and advances 4.80 20.50 2.57 13.65 2.56 14.39 Provisionsb 4.24 3.00 5.90 5.28 3.16 6.93 Other current liabilities 2.89 0.24 2.33 0.56 3.04 0.36 Total current liabilities -H————- -—————- —————— '—————— -—————— —————— Other liabilities 6.02 0.06 0.93 0.11 5.45 — Long-term debts 10.76 16.48 13.33 20.01 29.78 16.56 Preferred stock 6.63 1.54 7.57 1.13 3.16 2.98 Common stock 16.09 43.50 9.07 29.75 9.50 35.50 Retained earnings 38.97 6.50 47.69 14.68 36.00 15.80 Total stockhold- ers' equity Total liabilities and stockhold- 100.00 100.00 100.00 100.00 100.00 100.00 ers' equity aP = Parent; 8 = Subsidiary Provisions for taxations, dividend and contingencies. 163 F— ,7 l Electrical Chemical Other Petroleum n=1 n=5 n=7 n=2 P A P A P A P A 9.19 5.99 5.73 8.28 7.72 7.23 7.16 6.85 4.05 26.64 1.78 13.43 4.05 19.05 3.38 16.26 1 41 - 7.84 20.01 5.70 5.34 4.03 5.92 3 11 6.03 6.21 0.54 1.70 0.44 2.36 0.50 *———*——_ 7 80 - 2.02 0.30 1.37 0.20 6.86 0.13 39.24 — 10.29 6.46 15.39 18.36 12.58 4.17 0.03 - 3.13 5.12 2.22 2.24 - 1.25 1.27 59.34 5.94 28.27 9.05 32.76 9.73 32.09 33.90 8.00 57.06 17.59 52.80 14.38 53.91 32.93 ______ _______ _______ _______ _______ ,______ _______ _______ .éégai 67.34 66.13 50.98 64.07 49.38 63.64 66.27 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 164 As against this the long term debt of the parent corpora— tions is larger than their subsidiaries engaged in petroleum, chemicals and metal and metal products industries. All the subsidiaries operating in the different industries raised more capital through the issue of common stock than their parent corporations. On the other hand, the share of retained earnings of the subsidiaries is smaller than their parent corporations. Among the U.S. subsidiaries, the subsidiaries operating in the petroleum industry have retained more earnings than the other sub- sidiaries engaged in other industries. The debt-equity ratios of the subsidiaries operat- ing in transport, machinery, metal and metal product, chemical and petroleum industries are 0.99, 1.22, 1.06, 1.08 and 0.52 respectively whereas the same ratios of their parent corporations are 0.58, 0.61, 1.00, 0.50 and 0.47. Age-Wise Comparison.--Table 5:16 gives the details of the financial structure of subsidiaries and their parent corporations in the different age groups. The table indi- cates that the prOportion of the total current liabilities of the subsidiaries in all age groups is larger than their parent corporations. With the increasing maturity of the subsidiaries and better reputation in capital market they find it easier to raise current debt as the source of fi- nancing. On the other hand, the new subsidiaries established after 1957 have a greater percentage of long-term debt than 165 .mOHocmmcHucoo was OOOOH>HU .mcoHumxmu How mconH>OHm >HMHUHmQSm n m “ucmumm u m n M wuHsvm .mum oooo0H oo.ooa oo.o0H 00.00H 00.00H oo.ooa oo.ooa 00.00H IUHOSXUOum ham mmHuHHHsmHH Hausa vH.om vv.mm mm.mm mN.mm mH.hv HN.O® mm.mw mo.m© wufifivw .me IOHosxuoum H6009 Hm.v wm.mv mm.m mo.aw hm.NN wv.mv mv.mm Hm.mm mOGHGHmw fimcflmumm HN.o¢ mm.h m©.m¢ mv.OH mv.HN Ob.HH mm.HN mh.oa Moowm COEEOU Nm.m mH.NH mH.H mh.m mm.m mo.o vv.H I xOOum Umhhwmmum C¢.ON om.OH mm.mH mn.vH Nm.MH vw.hH NN.m om.NH munmw EH6¥IUGOH no.0 sm.m I me.m . mm.~ ee.e mm.H mmHuHHHemHH umspo Hv.mN mH.NN wN.om mm.wH mm.mm mm.mH mh.mv Hh.mH mmflUHHHQmHH #CGHHDU HMHOH. I om.v I vo.N hw.o mm.N mH.o Nm.v mmHHHHHQMHH “numb-”H50 ngflo mh.m mo.m Hm.¢ mm.v HN.OH ma.m mv.vm mh.w QmCOHmH>OHm mm.MH mm.H 55.5H Nb.m vm.mH OH.m mw.HH VF.N mOOGM>Um 0G6 mcmog mm.m mw.m mm.h v9.5 Hb.m HN.m mv.h mm.m OHQM%MQ mflfidOOOfi m m m m m m mm mm NHIC mug mun NmmH Hmlhmmfl mmIHmmH ommH muommm map so mcoHumuomHoo ucmumm cam A.Ommuamoumm :Hv mmHHchHmnOm mo Ousuosnum HmHocmsHmII.mHum OHnt .mmm mo mHmmn 166 their parent corporations but an opposite situation is noticed in the case of old subsidiaries set up prior to 1957. As would be expected, the proportion of the common stock of the new subsidiaries is much greater than their parent corporation and even greater than the old subsidi- aries. As the subsidiary grew older, the proportion of the retained earnings had also increased. The newest subsidiaries started in 1962 showed a debt-equity ratio of the 1.11 as against a debt-equity ratio of 1.18 for the oldest subsidiaries set up prior to 1950. Their parent corporations have a debt-equity ratio of 0.64 and 0.50 respectively. gynership-Wise Comparison.--Table 5:17 indicates that the U.S. subsidiaries in all the ownership groups have larger share of total current liabilities than their parent corporations. The share of long-term debt of sub- sidiaries is similar to that of their parent corporations. In each group, the U.S. subsidiaries have larger share of common stock and smaller share of retained earnings than their parent corporations. The debt-equity ratio of the subsidiaries in owner- ship groups 10%-25%,and 76% and above, are 1.13 and 1.08 as against 0.91, 1.00, and 0.92 for the subsidiaries fall— ing in the 26%—40%, 41%-50% and 51%-75% ownership groups respectively. The debt-equity ratio of their parent .mOHocwmcHucoo was OOOOH>HU .chHumxmu How chHmH>OHmQ wumHOHmnsm n m “ucmumm H mm hustm .mum 167 oo.e0H oo.OOH ee.OOH eo.oeH oo.ooH oo.OOH oo.e0H oo.oeH oo.OOH oe.OOH IeHossooum 0:0 mmHuHHHsmHH H0009 .m m. e 9. m m. m 9.Hm . . . . . muHsum .000 He 4 H m m H 9 0 H OH om Hm mm N9 mm 9m 96 Hm we IeHosxooum H0009 HH.m~ mH.~m mm.eH em.mm 94.9 m9.ms mm.m mm.HH mm.m em.Hm mmsHsumm emsHmumm me.mH OH.HH om.em He.m 90.0m 90.0H 99.H0 OH.HH vm.9m 9H.OH x0000 sossoo me.o mo.e I om.H 99.m em.m mm.H m~.9 He.H 04.0 90000 000009000 mm.HH mm.OH 69.0H mm.mH mm.mH mm.mH OH.om e~.mH mm.mH Hm.mH 00000 sumpImsou 94.0 mm.~ HH.o 9H.~ I 9H.H I me.m I He.H mmHuHHHsmHH 00sec 0 O O O O O O I O O mmHuI-fiHHQMH-fl 9H am He mm mm Hm H9 9H em em mm Hm mm mm mm mH O9 mm om mH 0000000 H0009 mo.o 99.~ I o9.m Ho.~ mm.0 ms.e ms.~ 0~.o m9.~ m0H0HHH00HH HGQHHDO H0330 9~.mH Hm.e m~.mH m~.e ee.e Hm.m 90.6 H~.0 HH.m He.m smsonHsoum He.mH mm.v oe.m Hm.~ em.mH mm.m em.OH 09.m mm.sm 99.~ 00000>00 600 memou oe.m 44.9 me.m «9.9 om.m m~.m H~.m ms.0 9o.m Hm.m 0Hsmsmd 00000004 m m m m m m m 0 mm mm ¢HC 6": fl "C . .mflq mug 0>00< 0:0 mos wmsImHm momeHs woeImem mmmeoH H.0mmpcwoumm QHV .HOOIMOOH mo mmmnm>mv mHzmuchO mo mHmmn 0:» so msOHumHomHoo ucmumm was mOHumHOHmQSm mo OHODOSHum HMHOGMGHMII.OHum OHQMB 168 corporations are 0.51, 0.53, 0.67, 0.66 and 0.53 respectively. Management-Wise Comparison.--The nature of manage- ment may influence the financial policy of the subsidiaries. Table 5:18 indicates that 50% U.S.-managed and wholly Indian managed subsidiaries have relied heavily on the total cur- rent liabilities than their parent corporations. The U.S. subsidiaries under the 50% American management have smaller long term debts than their parent corporations. In other cases, the parent corporations have more long term debts than their subsidiaries. The subsidiaries in all management groups have raised more capital by the issue of common stock than their parent corporations. The share of common stock in the case of subsidiaries with minority, 50% management and majority U.S. management is greater than the subsidiaries under wholly-American and wholly-Indian management. The above discussion shows that the American management does not in- fluence the financial structure of the subsidiaries. The wholly-Indian managed subsidiaries have a debt- equity ratio of 1.54 as against a debt-equity ratio of 0.68 in the case of wholly-American managed subsidiaries. This ratio of the majority, 50% U.S. and minority U.S.- nanaged subsidiaries were 1.11, 1.15 and 1.02 respectively. 'The debt-equity ratio of their parent corporations were 0.36, 0.43, 0.64, 0.60, and 0.54 respectively. 169 9000000000 .mmHocmde0coo 0:0 Osth>H© .msoHumxmu MOM mconH>OHm Q n m «ucmHmm H mm wuHsvm .mum 00.00H 00.000 00.00H 00.00H 00.00H 00.00H 00.00H 00.00H 00.00H 00.00H I0H0000000 000 00000H000HH H0009 em 0 N. com m o em 0. m 0 HQ. 0 o hgflsvm .mHm H9 0 00 9 09 0 00 0H 0 9 H 99 00 90 00 00 H9 90 I0Ho000000 H0009 00.0H H0.09 09.0 99.09 99.HH 0H.09 09.9 00.00 H0.00 09.99 09000000 00000000 0H.99 99.0H 09.H0 00.0 90.99 09.0H 90.09 09.9 09.90 99.00 00000 000000 90.0 I 90.9 90.9 I 00.0 00.9 99.0 90.0 I 00000 000000000 99.9 00.9 99.90 0H.0H 90.0H 99.9H 09.9H 99.9H 99.90 H0.0 00000 0000I0000 I 09.0 00.0 90.9 90.0 09.H 90.0 09.H 99.0 09.9 0000000000H 00000 . . . . .- . . . . . 00000000000 09 90 0H 0H H9 99 H9 9H HH 90 90 9H 09 99 9H 99 00 09 09 9H 0000000 H0009 09.0 90.9 I H0.9 90.9 9H.9 9H.9 H0.0 09.0 00.9 00000H0000H ucwuuso 00:00 99.HH 90.9 99.9 99.0 00.0H 99.9 00.9H 00.0 09.9 00.0 0000000>000 09.99 99.0 00.00 H0.9 99.0H 99.H 99.HH 09.9 90.HH 90.0 00000>00 000 00000 99.0H 90.0 90.9 09.9 H0.0 90.9 9H.9 90.0 09.0 90.0 0000900 00000000 0 0 0 0 0 0 0 0 00 00 Nuc .muc. 000 mun mud muouomuHo muouomuHo muouowuHQ muouomuHo 0000omuHo 000000 HH0 .0.0 90000000 .0.0 009 .0.0 9000090: .0.0 0H0 H.mmmucmoumm GHV .HBOIMOOH mo mmunm>0v-ucmsmmmcmfi Mo 00000 000 so msoHumuoduoo usmumm 000 mmHanOHmbOm 00 005009000 HMHOcmchII.OHum mHnme 170 Size-Wise Comparison.--TablesS:19(A), 5:19(B), and 5:19(C) present the information based on the size of total assets, total sales and total net worth, respectively. In all the size—groups, the U.S. subsidiaries have raised more funds from the total current debts than their parent corporations. The subsidiaries falling in the size groups (3) and (4) (Total Assets) and size-group (5) (Total Sales) have less share of long-term debt than their parent corporations. The subsidiaries in the size-groups (4) and (5) (Total Assets) have larger proportion of preferred stock investment than their parent corporations. However, the smallest subsidiaries have more capital from the preferred stock than the other subsidiaries in other size-groups. The share of retained earnings of the subsidiaries in all the size groups is smaller than their parent corporations but the largest U.S. subsidiaries have raised more funds from the retained earnings than the other subsidiaries. The above analysis shows that the U.S. subsidiaries followed a different financial structure than their parent corporations. The relative importance of the various sources of finance are determined by the provisions of the Control of Capital Issues Act, availability of loans from the Cooley funds,20 development of various financial 20For details, refer to Chapter II, p. 37 .mmHOcmmcHunoo tam OsmOH>HO .mcoHumxmu HON msOHmH>OHmQ wumHUHmndm u m «ucmumm H mm muHsvm .090 171 00.00H 00.00H 00.00H 00.00H 00.00H 00.000 00.00H 00.00H 00.00H 00.00H I0H0000000 000 0000000000H H0009 H9.99 09.00 00.90 09.00 09.09 00.09 90.00 00.99 09.H9 99.09 900000 .000 I0Ho000000 H0009 00.99 09.90 09.00 99.99 0H.HH 99.00 99.H9 09.99 99.9 00.00 09000000 00000000 99.99 00.0H 99.H9 00.0 00.90 09.9 99.9H 00.9H 90.90 00.00 00000 000000 00.9 09.H H9.0 99.0 I H0.9 90.9 I 09.0 90.HH 00000 000000000 09.90 09.90 99.9 09.0H 09.9H 00.9H 0H.0H H0.9 00.9H 99.9 00000 0000-0000 00.0 09.9 09.0 90.H I 99.0 I 09.0 90.0 90.0 00000H0000H 00000 99.99 99.90 H0.00 99.09 00.99 09.9H H0.H0 H0.0H H0.09 H9.H9 mmwwwwwnmwwo9 I 99.9 90.0 09.9 00.0 H0.9 90.0 90.0 I 00.0 00000H0000H 0009950 00:00 90.0 00.9 09.90 90.9 90.9 09.0 9H.0 99.9 00.9 0H.0 0000000>000 09.9H 00.9 0H.9H 99.9 H9.0H H0.9 99.99 90.9 99.0H 09.9 00000>00 000 00000 09.0 H0.0 0H.0 90.9 00.0 0H.9 99.9H 09.0 09.0H. H9.0 0H00900 00000000 0 0 0 0 0 0 0 0 00 00 0": bus mu: Nun bu: 0>000 99.099 09.00 09.00 00.90 00:» mmmH can 0m.mm .0 0030 mme can om.vw .m 0030 mmmH gm 0 O 0 99 090 9 000 00.90 .9 00:0 mmmH .H H.mmmu:moumm :HO .HhmlmmmH mo mmmum>mv mNHm HmHmHHOU mo mGOHHHHE GHV mummmm H0000 mo memn 0:0 so mcoHpmHomHoo ucmumm tam meMMHCHdem m0 mufiuonuum HMHocmthII.A¢VmHum mHnma .0000c0mcwucoo 0cm wc0wfl>0c .mcoflumxmu How mcoflmfl>oumn 0000000000 u 0 0 «uc0umm n m muwsv0 .000 172 00.000 00.000 00.000 00.000 00.000 00.000 00.000 00.000 00.000 00.000 I00o000000 000 00000000000 00000 .mmqme 00.99 90.09 90.90 90.90 09.90 09.90 99.99 99.09 99.90 I00MMMMWM0.%MM00 90.09 90.09 09.00 09.99 90.9 00.09 00.0 09.99 00.9 09.00 09000000 00000000 90.99 90.9 90.09 09.90 09.99 99.00 09.99 99.0 00.00 99.00 00000 000000 00.9 00.0 I I 00.9 99.0 I 90.0 00.0 99.9 00000 000000000 00.00 90.90 09.00 09.00 90.00 09.00 I 09.99 99.00 90.9 00000 0000I9000 99.0 00.9 00.0 00.0 I 90.9 I 00.9 90.0 99.0 00000000000 00000 . . . . . . . . . . 00000000000 99 09 99 09 09 99 90 90 00 99 99 90 00 99 09 90 09 09 09 09 0000000 00000 90.9 00.9 09.0 09.0 90.0 00.9 90.0 00.9 00.9 90.9 00000000000 HCQHHSU HGQUO 09.00 00.9 09.9 90.0 99.0 99.0 I 00.0 99.0 09.0 00000000000 90.90 99.9 00.09 99.9 99.99 09.0 00.09 90.0 00.90 00.9 00000000 000 00000 90.0 99.9 99.9 09.9 00.00 09.9 99.9 90.9 09.9 90.9 0000900 00000000 0 0 0 0 0 0 0 0 00 00 Hana 0n: 0na ans 9": 00000 99.90 90.90 90.00 99.00 c050 0000 0:0 mo.mm .0 cmgu 0000 cam mo.0w .m swap 0000 fiw mmm . 0:0 m~.mw .m I 0.0mwuc0ou0m :Hv .Ahm 0m000>0v 0000 Amumaaoc mo mcoflaaflfi :00 00000 0000» mo 09003 macaumuomuoo uc000m 0cm 000009000350 00 005005000 Hmwocmcflmll.0mv maum 00309 Imo¢H MO 030 :0 173 humacflmnzm n .mmflocmmcflucoo Una Ucm©H>HU .mGOHumxmu How meowmfl>oum Q s I m .ucwumm I mm wuflsvm .mum oo.ooa 00.00H oo.ooa 00.00H 00.00H oo.ooa 00.00H oo.ooa 00.00H 00.00H ucaonxooum can mmfluflaflnmfla Hmuoa Hm.mm vm.am ma.mm NH.oo ¢¢.mm mm.mn mm.m¢ mm.mo ¢¢.mq mv.nn muflsvm .mum loaoaxOOpm Hmuoa mn.>~ mm.mv nv.ma mH.om mm.mH Hm.mq mm.m mm.Hm mm.m HH.mm mmcflcumm cmcflmumm mm.- ov.oa mm.mm wm.m 5H.mm mm.- mo.o¢ mo.ma n~.¢m mn.v xooum aoeeoo oa.m mm.a o>.o Ho.H mm.m mm.m mm.H «H.¢ vm.m hm.ma xooum omuummmum mm.mH m~.ha mm.~a on.nH ov.ma mq.m ma.m um.m mm.¢m mq.m magma anmuumcoq mo.o wm.m ma.o mm.m . mH.m no.0 mm.~ . . mmfluflaflnmfla “mayo . . . . . . . . . . mmfluflflflnmfla mm um mm 5H NF mm mm ma Hm ¢N am on ma av ma om mm on no mm ucmuuso Hmuoa ma.o mh.m mH.o H~.N oq.o vm.~ . mm.~ . o>.m mmfluflHHQMHH ucwuuso uwnuo Hm.v ma.m mm.ma mm.¢ mm.m nm.m mo.m om.m vo.m hm.h nmcoflmfl>oum om.mH oo.m on.ma vo.m mo.ma mm.v ma.mm mm.v om.n mo.H mmoam>um gum mcmoq mm.n Ho.m o~.n oa.a mm.oa 55.0 ow.m vm.> Hm.m mo.m magmamm macsooo¢ m m m m m m m m mm mm mun «an: Nun qua mu: m>ogm mm.mw mo.mw mo.Hm ~m.om cmnu mmma cam mo.mw .v swap mmma mam mo.aw .m away mmmH QM mmm . cam mm.ow .N aa a H Una mm.mm .m Almmmpcmoumm :Hv .Ahmlmwma mo womum>mv muflm AmumHHow mo mcoHHHHE may nuuos pm: Have» mo mfimwn may no mcoflumuomuoo pcmumm cam mmHHMHwflmQSm mo musuonupm HMwocmcflmnl.onmaum magma 174 institutions for providing medium and long-term loans, confidence of the Indian people in the success of foreign collaborated enterprises as demonstrated by the over- subscription of common stock, willingness of commercial banks to provide loans, etc. Besides these, the nature of industry and the age of subsidiaries also have some impact on the financial structure. The large amount of short and long term loans in the financial structure of the subsidiaries should not be in- terpreted as the result of the liberal attitude of these subsidiaries regarding debt financing. The willingness of commercial banks,21 availability of Cooley funds, the development of institutional investors in recent years and the willingness of the parent corporations to provide or guarantee the loans have facilitated the debt financing. The U.S. subsidiaries have raised insignificant amounts of capital by the issue of preferred stock. The economic uncertainties and stagnation of the period and the change in the tax law in 1959 have made the issue of 21"Indian banks have been very eager to loan to U.S. affiliates even at the expense of long-established rela- tionships with purely local firms. . . . The U.S. firms have usually had no difficulty securing sizeable over- draft lines and large long-term loans either for new projects or for expansion of existing ones. The U.S. affiliates in India can secure banks accommodation on better terms and in larger relative amounts than the average Indian company." (Business International, India-Business Problems and Op- portunities, New York: Business International Corporation, 1961), p. 52. 175 22 Thus considering the economic preferred stock expensive. uncertainties, higher tax rate and the ease with which U.S. subsidiaries have sold common stock, there seems little reason to issue preferred stock in India during the period under study. The subsidiaries have smaller amounts of equity financing than their parent corporations. But on this basis, one should not conclude that the U.S. parent corpora- tions invested modest amounts of equity capital and tried to rely heavily on the loans and advances in the financing of their operations in India.23 The empirical evidence available in the present study points out that the U.S. subsidiaries have more than one-third of their total financ- ing in the form of common stock. Moreover, the newer sub- sidiaries started during 1957-62 have raised more than two-fifths of their total finance from the common stock. 22For instance, a cumulative redeemable preferred sold for 6.3% tax-free will cost a company about 9% de- ducting 30% of this payment as a withholding tax. Ibid., p. 56. 23Behrman reports from his study of 72 U.S. companies that "by far the majority of the respondents either keep equity dollar financing to the minimum or provide only the initial financing in the form of equity or combine both policies. (J. N. Behrman, Foreign Associates and Their Financing, in U.S. Private and Government Investment Abroad, Edited by Raymond F. Mikesell, o . cit., pI’QS. Brash's study also points out that "Many of these companies [U.S. companies] finance their operations in Australia without hazarding 'one dollar of American capital.'" (Donald T. Brash, American Investment in Australian Industry, op. cit., p. 79. 176 It is also true that as the subsidiaries mature, they tend more and more to utilize retained earnings for the financing of their operation. The larger amount of the retained earnings in the financial structure of the well- established subsidiaries supports this. It may also be emphasized that even if the U.S. parent corporations intend to adopt a policy of modest initial capital investment in their Indian subsidiaries, the Controller of Capital Issues does not allow any firm, whether foreign or Indian, to start their operation with thin capital resources. He scrutinizes the financial re- quirements of each enterprise at the time of issue of license and does not intend to repeat the practices of Managing Agency System.24 During the course of personal interviews, the executives invariably refuted the idea that the U.S. corporations started their operations in India with modest capital investments. One executive pointed out that the Controller of Capital Issues would not even approve the initial negotiation if the U.S. Corporations proceed with this intention. Dividend Policy The hypothesis regarding dividend policy is that the dividend policies of the U.S. subsidiaries are similar 24Refer to Chapter II, p. 39. 177 to their parent corporations. This hypothesis will be tested by comparing the dividend payout ratios of the sub- sidiaries with their parent corporations. If the former declares about the same percentage of dividend as the lat- ter, the hypothesis will be accepted; otherwise it will be rejected and the alternative hypothesis will be accepted. The dividend policy is an important variable af- fecting the investment policy of the firm. The dividend payout ratio, i.e., the percentage of earnings paid to the stockholders in cash, determines the amount of the earnings available to the firm for reinvestment purposes. Thus the reinvestment policy of the firm is closely associated with the dividend policy of the firm. Moreover, the dividend payout ratio provides some indication regarding the reliance of the U.S. subsidiaries on the retained earnings as a source of finance. It is commonly assumed that the U.S. subsidiaries in need of funds would prefer to rely more on the inter— nally generated funds than the outside funds. Due to this attitude, the subsidiaries will pay a lesser amount of earnings to the stockholders than do their parent corpora- tions. On the other hand, it is also argued that the U.S. corporations going abroad are primarily interested in the maximization of their profit and the remittance thereof in the form of cash dividends to their parent corporations. In a situation like in India where there is no restriction 178 on the remittance of profit, the subsidiaries may try to send the maximum amount of their profit to their parent corporations and depend on the Indian capital market for additional funds. Moreover, because of their reputation and the confidence of the general people in their future success it is not difficult for the U.S. subsidiaries to raise funds for financing their operation in India. The testing of the above hypothesis will throw some light on the above controversy. Overall Comparison.--Table 5:20 presents the divi- dend payout ratio of the U.S. subsidiaries and their parent corporations for the years 1963 to 1967. The table indicates that on the whole the sample U.S. subsidiaries have paid a larger percentage of their earnings as dividends than their parent corporations. The payout ratio of the subsidiaries is 55.99% whereas this ratio is 47.03% in the case of the parent corporations. Table 5:20.—-Dividend payout ratios of subsidiaries and parent corporations. (In percentage.) Year Parent Subsidiary 1963 50.77 61.72 1964 46.86 51.47 1965 45.79 61.46 1966 41.50 63.44 1957 50.24 41.85 Average 47.03 55.99 179 Group-Wise Comparison.-—The above data show that the subsidiaries have relied less on the reinvestment of their earnings and have paid more dividend than their parent corporations. But such a conclusion based on the overall comparison of the dividend payout ratios of the U.S. subsidiaries and their parent corporations would not be justified, and a detailed analysis of the dividend pay- out ratios of these subsidiaries based on their nature of industry, age, ownership, management and size may reveal a different picture. In the following pages, the dividend payout ratios of subsidiaries and their parent corporations have been analyzed on the above basis. Industry—Wise Comparison.--Table 5:21 indicates that the U.S. subsidiaries engaged in transport equipment and petroleum industries have paid less dividend than their parent corporations whereas the subsidiaries operat- ing in the machinery, metal and metal products, and chemi- cal and allied products industries have paid more dividends than their parent corporations. Subsidiaries and parent corporations engaged in 'other' industries have paid simi- lar percentage of their earnings as dividend. The highest dividend payout ratio (i.e. more than 70% of the earnings) was observed in the case of the subsidiaries engaged in the production of machinery, and chemical and allied products. "- all 180 .mHMHpHmUSm u m «ucmumm H mm 5v.ma wo.mm mm.mv mo.mv Ho.ah mb.mm hm.mm vm.wv wm.mm om.ab mm.mm vm.mm mm.~v .m>¢ mm.m~ hm.vm mm.mv mm.am Hm.mm Hm.mm N~.mm mv.vv mo.am mH.Hm vh.mm mm.mm mm.vm hmma na.mm em.mm mm.om ww.mv mm.mm m~.mm mv.mm om.m~ mm.mm ev.~w oa.mm Hm.hv ww.mm mmma vh.va vm.mm hm.am av.mv mm.mm wm.mm hm.om mo.mm mm.m~ vv.oqfivo.mm wo.va mo.ov moma ha.¢ mm.om Hm.mm mm.mv mm.¢m mm.hm No.5m mv.mm mm.mm om.n> mv.hm I ww.vv vmma vm.a Nh.mm mm.v¢ mm.mm mm.m> mm.mm hm.mh mm.mm mm.m¢ mm.vm Nv.mm I ~v.mv mmma m m m m m m m m m m m mm on N": fins mud and mud mu: v": mDUSUonm Eswaouumm muwcuo HMOflEmno Havauuowam Hmumz mumcflcomz uuommcmue mam H302 A.mmmucmoumm ch .mHUmsvcH mo mammn map so mc0flumuomuoo usmnmm paw mmflumapflmndm mo mOADMH usowmm pampfl>annl.amum magma 181 Age-Wise Comparison.--Tab1e 5:22 reveals that the well-established U.S. subsidiaries (i.e. started prior to 1956) have paid more dividends than their parent corpora- tions. The same is true for the subsidiaries set up dur- ing 1957-1961. Only the new subsidiaries started in 1962 have paid less dividends than their parent corporations. Moreover, the maturedsubsidiaries started prior to 1950 paid two-thirds of their earnings as dividends as against one-third by the new subsidiaries. Ownership-Wise Comparison.--Table 5:23 indicates that the U.S. subsidiaries with more than 41% U.S. owner- ship have paid more dividends than their parent corporations. The payout ratio of the subsidiaries with ownership between 26% and 40% is lower than their parent corporations. But this is not true in the case of the subsidiaries with 10% to 25% U.S. ownership group. Management-Wise Comparison.--Table 5:24 reveals that the dividend payout ratios of the subsidiaries managed by majority and 50% U.S. directors are greater than their parent corporations. The dividend payout ratios of wholly-Indian Managed and minority U.S. managed subsidiaries are lower than the U.S. parent corporations. The wholly- managed American subsidiaries have paid the lowest amount of the earnings as dividends of any of the management groups. 182 Vibe . “HE.“ E 1...“ m .MMMHpfimQSm n m “ucmumm H mm mm.Hm Hm.mv mm.om 5v.mv nv.mm 5H.mm Hm.mm vm.~m mmmum>¢ mm.mm om.mm no.mm m>.mv mm.mm Hm.nm wm.om on.mm hmma ma.mv mm.mm om.an mo.Hv ma.mm mw.mm mo.mm mo.mw coma Hw.m~ mm.mv Hm.Hm mm.hv mm.mm mm.mm hm.hn hm.m¢ mmma no.oH mm.mv vh.ov mm.mv an.mm no.5m mw.mm ah.om vmma I om.ov 5H.mv mv.mm om.mm mm.mv mo.mw mm.mm moma m m m m m m mm mm mu: Nan: mud. mus mmma Hmnbmma mmIHmmH omma mHOMmm A.mmmucmoumm nHV .mmm mo mammn may :0 mcofiu Imuomuoo ucwumm can mmaumflpHmQSm mo weapon D50%mm pampw>floII.m~um manna 183 .mumflwflmnsm m “ucmumm u m m mm.mm mm.Hw n>.mo va.mm ma.mm mn.mv mm.hv mn.om ma.am Hq.Hv mmmum>< 5H.mm Hm.mw mm.mm mo.mm ~m.¢a Hm.¢m mm.mm oo.mv mn.nm mm.~¢ nmma mm.nn op.hm Hm.mh na.nw mw.>m mm.mm Ho.mv mo.Hq av.mm mm.mm mmma ~m.mm mm.H¢ am.mh hm.om mm.mm Hm.vv mm.vm mH.om Hm.mn m~.Hv mmma mm.«m Hp.mv mm.mm mm.qm mv.nm no.6v mv.mm H>.Nm uo.mv wm.mm «Baa om.vm Hm.mv mo.sm ~m.mm mm.mn na.mv mm.mm ww.om ev.h¢ om.qw mmma m m m m m m m m mm mm vnc wnc c a : Hmmw mm» m>oa< Amp mam mom was woe mmm mmm woa :0 mcoflumuomuoo “.mmmucwoumm GHV .mwnmuwczo mo mamas mnu ucmumm cam mmflumflpflmndm mo moflumu unommm UchH>HoII.mmum GHQMB 184 1" .mnmfloflmnsm m «ucmnmm fl mm.am ~H.¢m No.0v mm.m¢ mm.Hm mm.nm mm.qm Hm.>v mm.H~ mm.am mmmum>¢ om.h~ mm.om mw.nm mm.>v H~.Nm mv.av mo.mm mm.mm mo.~v om.Hm poms mm.mm mm.mv a~.mv ma.mm Hm.om om.vm ¢N.H> mo.mv mm.ov mh.mv mama No.66 om.om ma.m¢ m~.mv Hm.Hm mo.¢m h~.mm «H.0v mm.ma Ho.om mmma mo.m¢ no.mm os.m~ H¢.m¢ «n.5m mm.mm oa.qq Ha.mv na.¢ mm.~m «mad mm.Hm Hm.Hm mm.mn m~.pm sa.nn em.m¢ mm.am mm.ma ao.H om.am mead m m m m m m m m mm am «I: an: an: mu: mus mHOpomeQ mnowmwwwo wom I mom muowmwmflo muouowuwa unflwcH Haa mufluoaflz mufiuommz .m.p Ham co mGOwumuomuoo A.mmmucmoumm GHV ucmumm paw mmflumprmQSm .ucmfimmmcwe.motmwmmn on» no moaumu usommm pcmcfi>fioII.vmum magma 185 Size-Wise Comparison.--Table 5:25 presents the dividend payout ratios of the U.S. subsidiaries and their parent corporations on the basis of size groups (total assets). It is evident that among all the size groups, the smallest and largest sized subsidiary groups have paid about one-third of their earnings as dividend whereas their parent corporations paid about one-half of their earnings. 1 In the case of other size groups, the subsidiaries paid two-thirds as against less than one—half by their parent corporations. High and Low Payout Ratio.--Besides the difference in the dividend payout ratios, the high and low payout ratios of the subsidiaries differ from their parent cor- porations. There are greater fluctuations in the high and low dividend payout ratios of the subsidiaries than their parent corporations. In the case of industry, the sub- sidiaries (operating in petroleum industry) paid as low as 19.47% and as high as 71.30% (engaged in machinery in- dustry). In the case of parent corporations, high and low ratios were 32.54% and 63.37% respectively. In the case of subsidiaries classified on the basis of age, their pay- out ranged from a low of 31.66% to a high of 65.51%, as against this, the ratios varied between 38.17% and 53.47% respectively for the parent corporations. The high and low payout ratios of the subsidiaries studied on the basis of their management varied between 22% and 82% whereas these r .. t 3 Fzfln. "E. :01". . .wumapwmndm u m «ucmumm u m M 186 H4.mm mm.~m mm.c> mm.44 44.44 44.~4 5H.nm hm.~m h~.4m mm.44 mmmum>¢ oo.~4 mm.om mm.mm Ho.m4 m4.mm ~m.m4 00.4 «n.5m 4~.am M4.~4 5444 mm.mm hm.m4 4~.mm on.~4 m>.mm mm.4m mo.4m FH.~4 mo.am HH.O4 mead m~.4m m4.m4 m~.m4 4~.44 mm.~4 45.nm os.mm 4m.m4 44.44 mm.m4 mmma mm.- ~4.~m nm.mn Hm.m4 hm.om no.4m m4.4m 4~.hm no.44 O4.om 4444 mm.4~ 04.44 mm.ms «4.44 o~.~a mm.mm ~4.4m 54.~4 I 44.om mmma m m m m m m m m mm mm on: bus mud mus hum ucm>mmwo~m cmmwOmmmH cmmm mmma ammm wmoa cmwm.mmmq gum» can om mm 6cm om 44 wen we Na A.wmmusmoumm :Hv .AmHmHHop mo mGOHHHHE Gav mummmm Hmuou mo mammn on» so mcowpmuomuoo ucmumm paw mmflHMAcflmQSm mo moaumu Dachau pam©fl>HQII.mmum anMB 187 ratios were 38% and 54% respectively in the case of the parent corporations. The groquise comparison of the dividend payout ratios of the U.S. subsidiaries and their parent corpora- tions indicates that in few cases the parent corporations have paid higher dividends than their Indian subsidiaries - while in most of the cases the U.S. subsidiaries have paid more dividends than their parent corporations. In response to the reasons (Question No. 10 of Appendix 1) for the retention of the earnings of their Indian subsidiaries, I one-half parent corporations pointed out that their sub— sidiaries had retained their earnings because of better return or just for reinvestment purposes. One-fourth of the parent corporations mentioned that they did not retain their earnings. One-fifth pointed out that their subsidi- aries retained their earnings in India because of the majority ownership by the Indian partner or some restric- tions on the remittance of profit. The details are given in Table 5:26. Table 5:26.--Reasons for retentions of earnings in India. Number of Companies Better return on reinvestment in India Don't retain Majority ownership by Indian partner Restriction on remittance of profit (nth-WM!“ O Other reason (reinvestment) Totala l'-' ONUONWIth a O 0 Two U.S. corporations mentioned two reasons each. 188 From the above discussion one should not conclude that the U.S. subsidiaries as a uniform policy, have tried to remit an unusual share of profits to their parent cor- porations in the U.S.A. A comparison between the dividend payout ratios of the Indian Public limited companies and U.S. participating subsidiaries reveals this fact. The 1;: dividend payout ratios of 1,333 selected Indian public Limited companies25 for the years 1963-64, 1964-65, and 5 1965-66 were 61.3%, 61.5% and 64.1% respectively whereas these ratios were 61.72%, 51.47% and 61.46% of the sub— 26 I I"-'.~‘1 “-76“. )..i sidiaries in this study. It indicates that the U.S. subsidiaries, no doubt, have paid higher dividends than their parent corporations but these ratios were not at all higher than the Indian public limited companies. Moreover, the dividend payout ratios of U.S. corporations, on the whole, for the years 1963, 1964, 1965 and 1966 were 49%, 45%, 43% and 43% respectivelyz7 whereas these ratios were 50.77%, 46.86%, 45.79% and 41.50% for the 27 U.S. parent 25Reserve Bank of India, "Finances of Indian Joint Stock Companies--l965-66," Reserve Bank of India Bulletin, December, 1967, p. 1537. 26The figures of selected Indian public limited companies are based on historical cost while the figures of U.S. subsidiaries are on price-level adjustment. 7Economic Report of the President, (Washington, D.C.: U.S. Government Printing Office, 1967), p. 290. 189 corporations. Thus the dividend payout ratios of these parent corporations were similar to that of U.S. corpora- tions on the whole. On the above basis, it is not appro— priate to conclude that the U.S. subsidiaries have tried to remit more profit to their parent corporations. Summary The main purpose of original investment by the U.S. corporations in India was the expectation of profit. But the U.S. corporations were not overly concerned about profit in the short-run but to expand their market and 1;; earn profit in the long-run. To explore the opportunity and the possibility of investing in a foreign country, the U.S. corporations typically conduct a broad survey of the economic, political and other environmental situations of the foreign country. U.S. corporations use various quan- titative and qualitative techniques for evaluating the various alternative proposals. The comparison of the assets composition of the subsidiaries and the parent corporations, on the aggregate level, indicates that the subsidiaries did not follow similar investment patterns as that of their parent cor- porations. Subsidiaries had relatively more investment in net fixed assets and inventories than their parent cor- porations. The parent corporations had invested relatively more in cash and marketable securities and accounts 190 receivable than their Indian subsidiaries. The comparison of the investment pattern of the parent corporations and their Indian subsidiaries on the basis of industry, age, ownership, management, and size indicates that the general pattern of investment as emerged from the aggregate level comparison is not found in the case of some subsidiaries. The over-all comparison of financial structure of the parent corporations and their Indian subsidiaries in- dicates that the subsidiaries have not adopted a similar financial structure as that of their parent corporations. The U.S. subsidiaries relied more on the short— and long- run debts and common stock than their parent corporations. The parent corporations depended more on retained earnings whereas the retained earnings, on the whole, were not the major source of finance in the case of subsidiaries. Pre- ferred stock played an insignificant role as a source of capital in the case of both parent corporations and sub- sidiaries. The group-wise comparison indicates that the pro- portion of the common stock of the newer subsidiaries is much greater than their parent corporations and even greater than the older subsidiaries. The management and ownership do not seem to influence the financial structure of the subsidiaries. The U.S. subsidiaries, on the whole, have paid higher percentage of their earnings as dividends than 191 their parent corporations; but not greater than other Indian companies. Moreover, the well-established subsidiaries have paid higher dividends than the newer subsidiaries. The ownership and management do not seem to have signifi- cant influence on the dividend payout ratios. But there were greater fluctuations in the high and low dividend payout ratios of the subsidiaries than their parent corporations. CHAPTER VI PERFORMANCE OF SUBSIDIARIES It is often assumed that a developing country like India provides vast natural resources, cheap labor, a growing market and weaker local competition. Due to these factors, the profits earned by foreign enterprises on their investment in India are high as compared to their domestic investment. On the other hand, others argue that the rates of return in such a country would be lower than in the U.S.A. because of the inefficiency of factors of 'production, high cost and/or lack of availability of in- puts, lack of economies of scale, etc. Besides these op- posite views, there is another that though the rates of return may be greater in India, they are not great enough to offset the high degree of risks associated with doing business in India. The main purpose of the present chap- ter is to examine and evaluate this aspect by studying the parent corporations' goals for subsidiaries, noting actual rates of return, and the nature 0f risks (both business and non-business risks) associated with foreign investment. As has been pointed out in Chapter V, the main ob- jective of the U.S. corporations investing in India was to 192 193 earn profit. But the parent corporations were not overly concerned with the short—run profit so long as they expand their market and earn profit in the long-run.1 The perfor- mance of U.S. subsidiaries would be evaluated in the context of the above objective. It is proposed to be done by testing the following hypothesis: The performance of U.S. subsidiaries in India is similar to that of their parent corporations in the U.S.A. (Ho). The alternative hypothesis is that the performance of U.S. subsidiaries in India is materi- ally different from their parent corporations in the U.S.A. (Hi). There are different ways and techniques to measure the performance of a subsidiary. It may be measured on the basis of profitability, market penetration, productivity, industrial and labor relations, personnel development, public and government relations, etc.2 In the present study, the performance of the U.S. subsidiary is measured on the basis of the "return—risk" concept of the perfor- mance. The "return-risk" concept suggests that while evaluating the performance of the firm, we should consider 1Refer to Chapter V, 2 I l I I For a detailed discuSSion, see BuSiness Interna- tional, Evaluating_Foreign Subsidiary Performance, Manage- ment Monograph No. 14, (New York: Business International Corporation, 1964), pp. 2-14. .47.. i '. ‘ m .1".Wc..)'o 194 both rate of return and nature of risks associated with such performance. Financial theory indicates that rational manage- ment will not choose riskier investments unless the ex- pected rate of return increases sufficiently to offset the increased risk. In other words, "as risk increases, higher and higher expected return on investment are re- quired to compensate investors for the additional risk."3 The "return-risk" concept can be explained with the help of a two-parameter model. The model describes the trade- off between the expected rate of return and the risk. This can be explained with the help of Figure 6.1. Figure 6.1 Risk I II Ri Yi 2 R Y ”,/’/ / , Return x x1 x2 Suppose the firm can be visualized at point R on the indifference curve I with an expected rate of return of X and of risk y. Suppose the risk increases from Y to Yi. If the rational manager is indifferent, he would 3J. Fred Weston and Eugene F. Brigham, Managerial Finance~ Third Edition, (New York: Holt, Rinehart and Winston, 1969) p. 224. ‘1‘“ P“ .h‘. '2. _,r 195 expect that his rate of return should increase to Xi to offset, at least, the increased risk. He will be at the point Ri. To compensate for the increased risks, he would expect higher expected rate of return, i.e., he would be at point R2 on new indifference curve II. Thus a rational management would invest money only when the increase in risk is compensated by the higher rate of return. . Part I discusses the rate of return while Parts II and III describe the nature of business risk and environ- 1 j—rsa . mental or non-business risk respectively. PART I Rate of Return The rate of return is measured on the basis of the profitability ratio which gives us an indication of the firm's efficiency of operation. This can be evaluated in two ways; those showing profitability in relation to sales and those showing profitability in relation to in- vestment (i.e., total investment in the firm and total stockholders' investment.) The rate of return on total sales measures the former whereas the rates of return on total assets and net worth measure the latter. Measurement of Rate of Return The rate of return of subsidiary and parent cor- porations is measured for each year on the following basis: 196 (1) Return on Total Assets; The ratio of net profit after tax to total assets measures the rate of return on total investment in the firm. Netgrofit After Tax Total ASsets Return on Total Assets = (2) Return on Net Worth: The ratio of net profit after tax to net worth measures the return on stockholders' in- vestment. Net Profit After Tax Return on Net Worth = '__Total Net WOrth (3) Return on Total Sales: The ratio of net profit after tax to total sales measures the profit margin of the firm. Net Profit After Tax Total Sales Return on Total Sales = After calculating the rate of return on the above three bases for each subsidiary and parent corporation for each year (from 1963 to 1967), the arithmetic mean of rates of return on total assets, net worth and total sales of all subsidiaries and their parent corporations were calculated for each year. From these figures, the five- year mean rates of return of subsidiaries and their parent corporations were computed. The same procedure was fol- lowed for computing the annual and five-year mean rates of return for the different groupings of subsidiaries and their parent corporation. 197 Overall Comparison4 Table 6.1 gives the annual and five-year average rates of return on total assets, net worth and total sales of all subsidiaries and their parent corporations for the years 1963 to 1967. The data indicate that the five-year average rates of return of the U.S. subsidiaries on total assets and net worth were 5.20% and 10.24% as compared to 7.81% and 12.09% respectively for the parent corporations. On the other hand, the five-year average rate of return of i the U.S. subsidiaries on total sales was 7.94% as against 7.22% in the case of parent corporations. Thus the parent corporations were earning higher five-year rates of return on total assets and net worth than their Indian subsidi- aries. As against this, the subsidiaries were earning higher rates of return on total sales than their parent corporations over the five-year period. The main reason for the lower rate of return on total assets may be due to the lower turnover of total assets of the subsidiaries as compared to their parent corporations. Moreover, the subsidiaries were often newer enterprises with relatively undepreciated assets. The fear of the continuing import restrictions on plant and machinery, expectation of long term growth of market 4The U.S. subsidiaries' figures are based on ad- justed financial statements. Table 6:l.--Rate of return of subsidiaries and parent 0 ’J corporations on total assets, net worth and total sales (in percentage). Total Assets Net Worth 4 Total Sales Parent Subsidiary Parent Subsidiary Parent Subsidiary 1963 1964 1965 1966 1967 Average 7.08 10.50 11.88 12.47 13.59 11.72 12.09 1.60 7.94 for their products, inflationary trend in the developing economy and a precautionary attitude on the part of the subsidiaries might have induced the U.S. subsidiaries to build excess capacity. Moreover, Indian economy experi— enced recessionary trends in industrial production and general stagnation in the economy during these years. Due to this situation, there was underutilization of the capacity of the manufacturing sector.5 growth of industrial production declined from 9.4% in 1963 to 1.4% in 1967. It indicates the adverse economic 5Reserve Bank of India, The annual rate of "On Recent Recessionary Trends in Organized Industry," Reserve Bank of India Bul- letin, XXII, (July, 1968) pp. 866—867. ‘4..-—_'r*_ 7' 5.". i~ I' 1.99 situation in India during the period under study. As against this, the turnover rates of total assets of parent corporations were much higher than their Indian subsidi- aries. During these years, the U.S. economy witnessed sustained growth unparalleled in the history of this country. Due to this, there was hardly any idle capacity. The higher rate of return on total sales of the subsidiaries indicates that the profit margin on their total sales was greater than their parent corporations during these years. As against this the parent corpora- tions typically face much more competition from the many firms Operating in the same business and their capacity to charge higher prices for their products is significantly limited. Group-Wise Comparison From the above analysis, one should not conclude that all U.S. subsidiaries were earning lower rates of return on their total assets and net worth or higher rate of return on total sales than their parent corporations. A detailed analysis of the rates of return of these sub- sidiaries on the basis of their products, age, ownership, management and size indicates that some subsidiaries were earning higher rates of return than their parent corporations. 200 Industry-Wise Comparison.-—Table 6.2 shows that the U.S. subsidiaries engaged in all the different indus- tries included (except metal and metal products) have lower five-year average rates of return on total assets than their parent corporations although the difference was only slight for petroleum and 'other' industries. In other cases, this average rate of return on total assets is much lower than their parent corporations. Table 6.3 indicates that five-year average rates of return on net worth of the subsidiaries Operating in all the different industries (except metal and metal prod— ucts) were lower than their parent corporations. The subsidiaries engaged in machinery, and chemical, industries were earning slightly less than their parent corporations. The subsidiaries engaged in petroleum industry showed heavy losses in 1963 and because of this the overall average rate of return declined significantly; otherwise the four-year average rate of return would have been higher than their parent corporations. Table 6.4 reveals that the five-year average rates of return on total sales of the subsidiaries engaged in transport equipments, machinery, metal and metal products and 'other' industries were higher than their parent cor- porations. The metal and metal products subsidiaries were earning more than thrice as much as their parent corporations. 201 .mmaumavamnsm n mumcoflumuomuoo ucmnmm u m o u o m 5m.w ca.b NH.m h¢.m mm.h om.HH MH.H om.HH hm.m hm.v mm.v om.m mm.a mm.m .m>< mH.m mm.m hm.m om.m mm.m ov.oa mm.0I Hm.m ho.m mv.¢ ow.m mH.m mm.m mm.m hmma vm.h mh.w mm.m hm.m mm.m wm.ma HH.¢ mH.vH mm.va mm.m mv.m oo.m mh.m no.5 woma om.ma oa.h om.v Nv.m om.h ow.NH mm.m mm.ma mv.¢ mm.v vm.m HH.m ma.m N¢.m mmma wv.b hm.h mw.m mm.m mm.h m5.HH mm.ml mm.NH mm.m mm.¢ mm.v mm.m mm.HI wa.m vmma vm.HI mv.h wo.oa mm.m Nh.h Hm.0H mN.OI No.m mH.H mw.¢ ow.m vm.m vm.~I vm.m mmma m m m m m m m m m m m m mm mm NHG Fun mug Hug mug mug @"C macawoum ma cm cmfimasv Esmaouuwm muwnuo UHWWMMOMU HMUHHuomHm wcwmwwwmz wumcflsomz Whommmmuw A.mmmucwonmm ch .Ammw3lhuumspsHv mcoflumuomuoo ucmumm paw mmHHMHpHmQSm mo mummmm Hmuou so eunuch mo mummII.mum magma .mmaumapamnSm u m “mGOMDMHomHoo ucmumm u m hm.m mN.HH mw.m vm.oa mm.mH mo.hH HV.N mN.NH Ho.HH Hm.0H mb.oa hm.HH vm.v mm.0H .m>< 202 mm.HH mB.HH mh.oa mv.oa Nm.MH H¢.mH wm.~I mm.¢ Hw.w mo.oH om.m hm.~H om.HH mv.m homa vo.oa mm.HH mm.NH hm.HH Nh.mH mm.ma vm.m mv.oH ov.mm N¢.HH mb.NH mm.ma ov.ma mo.mH ooma 5N.mH mm.oa om.w vm.m mH.hH mm.mH Nv.ma wv.va 5v.m wh.oa wH.m mm.ma hm.m mm.oa mwma vm.ma Hm.OH wa.m H©.OH vm.ha Hm.bH mm.ml mw.NH hm.m mh.m vm.oa mv.HH mm.wl wv.m voma vw.bl HH.HH Hm.H mH.m mm.ha fim.mH Hw.0I No.m Hh.m Hm.m Ho.MH vo.m HB.NI mH.m mwma m m m m m m m m m m m m mm mm «as sun mun Hug mug mu: 4": Sam on m mum pmflaam can moan om muowpwum mumca 0m unmemflsvm H p m :uo Hmoasmgo H . u Hm a u z .n 2 unedmcmue . can Hmuwz A.mmmucmonmm cHV .Awmfl3Iwuumzoch mcoflumnomuoo usmnmm paw mmHHMAUHmndm mo nuno3 um: so canyon mo mummII.mum magma 203 m umcoflumuomuoo ucmumm u . . . 4 om.v mo.a mm.m om.m mo.m Hm.oa mm.a mo.ma hm.ma ma.w ma.b oa.m mh.m mm.w .m>< mo.oa mh.m mm.m bo.m mm.h om.m mm.HI mm.m vm.m oH.m mm.h hm.w mm.b Hm.m bmma 4o.m hm.m mo.vH vh.m vh.m mH.HH mm.m mm.vH mH.Hm mm.m mo.m mm.m hm.oH om.v mmma hm.ma Hm.m mm.m no.0 mv.h mm.HH mm.ba mv.va mo.vH mm.m ov.m mo.m mm.v Ho.w. mmma no.oa va.m mm.m Hm.m mm.> no.HH mm.mHImH.va mo.m mm.m Hm.m om.m vm.m ma.v vmma mm.mHI mv.m mo.NI mm.m mo.m ov.oH mm.HI mm.HH Hm.m H>.m om.m Hm.m mv.o Ho.v mmma m m m m m m m m m m m m mm mm N": 5".“ mug Hug mung mug Qua muosooum Umflaad Una ucmfimflsvm Esmaouumm mumnuo HMOflEmso HMOHHpomHm pawmmmwwz hnmcflnomz “Hommcmua A.mmmudmoumm :Hv macaumuomuoo ucmumm paw mmflHMHUHmnsm mo mmamm Hmuou so Guano“ mo mummll.vum manna .AmmH3IwuumSpGHv 204 The subsidiaries engaged in the chemical and allied products and petroleum industries earned less than their parent corporations. The variations in the rates of return in different industries may be attributed to the varying degree of im- pact of the recession on the different industries. For instance, the rate of growth in basic industries declined from 14.5% in 1963 to 2.1% in 1967; the rate of growth of capital goods industries increased from 13.5% in 1963 to 24.4% in 1964 and then declined to 10.6% in 1965 and 2.2% and 1.0% in 1966 and 1967, respectively. The growth rate in the case of consumer goods industries increased from 5.4% in 1963 to 7.5% in 1964 and then started declining and was —3.5% in 1967. Age-Wise Comparison.--Tab1e 6:5 indicates that the subsidiaries in all the age groups were earning lower five- year average rates of return on total assets than their parent corporations. However, the old subsidiaries were earning higher rates of return than the newer subsidiaries. Table 6:6 shows that the well-established U.S. subsidiaries which started prior to 1950 were earning a five-year average rate of return of 15.98% on net worth as compared to 12.97% by their parent corporations. The sub- sidiaries falling in other age-groups were earning less than their parent corporations. A striking feature of the over-all average rates of return is that the five-year 205 Table 6:5.—-Rate of return on total assets of subsidiaries and parent corporations (Age-wise). (In percentage.) Before 1950 1951-56 1957-61 1962 n=5 n=5 n=12 5 Pa sa P s P s P s 1963 8.25 5.15 6.22 5.64 6.16 -O.79 8.83 -0.68 1964 8.93 8.81 6.72 4.81 7.15 2.52 9.83 0.80 1965 9.14 6.99 7.42 3.83 7.54 6.18 9.51 4.01 1966 8.74 7.11 6.87 5.46 8.55 9.52 9.40 5.43 1967 7.11 .5.26 6.86 4.17 7.49 5.58 7.31 3.06 Average 8.43 6.66 6.82 4.78 7.27 4.60 8.83 2.52 a P = Parent Corporations; S = Subsidiaries. Table 6:6.-—Rate of return on net worth of subsidiaries and parent corporations (Age—wise). (In percentage.) Before 1950 1951-56 1957-61 1962 n=5 n=5 n=12 n=5 Pa sa P s P s P s 1963 12.43 12.90 9.52 11.48 8.97 -1.52 13.02 2.21 1964 14.03 20.77 10.75 10.73 10.45 5.40 14.09 1.43 1965 14.15 16.60 11.65 7.90 11.39 11.21 14.17 8.51 1966 14.03 16.73 12.08 13.49 13.50 16.43 14.89 12.26 1967 11.23 12.91 12.37 7.37 11.67 9.71 11.68 10.73 Average 12.97 15.98 11.27 10.19 11.20 8.25 13.57 7.03 P: Parent Corporations; S = Subsidiaries. 206 average rates of return showed an increasing trend with the maturity of the subsidiaries and after some time the U.S. subsidiaries started earning greater rates of return on net worth than their parent corporations. This may be attri- buted to the fact that with the passage of time the subsidi- aries try to adjust with the Indian condition and explore the various Opportunities of earning high profit. The new subsidiaries take some time to overcome the initial obstacles. Table 6:7 reveals that the U.S. subsidiaries started after 1951 earned higher five-year average rates of return on total sales than their parent corporations. Table 6:7.--Rate Of return on total sales of subsidiaries and parent corporations (Age-wise). (In percentage.) Before 1950 1951-56 1957-61 1962 n=5 n=5 n=12 =5 Pa sa P s P s P s 1963 8.00 5.31 6.36 7.07 6.85 —6.39 6.06 14.11 1964 8.36 8.36 6.70 6.23 7.46 3.57 6.53 5.90 1965 8.73 7.13 6.31 4.83 7.89 11.43 6.41 3.11 1966 8.48 8.13 6.33 8.47 8.46 26.17 6.30 8.72 1967 6.91 5.91 6.72 6.49 7.43 10.10 5.18 8.11 Average 8.10 6.97 6.48 6.62 7.62 8.98 6.10 7.99 207 Ownership-Wise Comparison.-—Table 6:8 indicates that the U.S. subsidiaries in all ownership-groups were earning lower five-year average rates Of return on total assets than their parent corporations. Table 6:9 presents the rates of return on net worth of the subsidiaries in the different age groups along with their parent corporations. The subsidiaries with above 75% U.S. ownership earned higher five-year average rate of return than their parent corporations. In other owner- ship groups, the five-year rates of return were smaller than their parent corporations. Table 6:10 indicates that the five-year average rate of return on total sales of subsidiaries falling in 10% to 25% ownership groups was higher than their parent corporations. In other ownership groups, the rates of return of subsidiaries were lower than parent corporations. Management—Wise Comparison.--Tables 6:11, 6:12 and 6:13 present the rates of return on total assets, net worth and total sales, respectively, of U.S. subsidiaries on the basis of their management along with their parent corpora- tions (Tables 6:11 and 6:12 (except above 75%) indicate that subsidiaries in all the management groups were earning lower five-year rates of return than their parent corporations. Table 6:13 indicates that the subsidiaries in all management groups except wholly-American managed, earned higher five-year average rates of return on total sales 208 Table 6:8.--Rate of return on total assets of subsidiaries and parent corporations (Ownership-wise). (In percentage.) 10% to 25% 26% to 40% 41% to 50% 51% to 75% Above 75% n=8 n=5 n=4 n=6 n=4 S P S P S P S P S 1963 5.39 2.29 5.58 -4.23 9.28 -l.43 8.76 4.16 7.22 7.49 1964 7.23 2.07 5.92 3.43 9.08 1.19 9.76 6.09 7.83 6.68 1965 7.60 3.60 6.09 7.68 8.94 4.55 10.21 6.32 8.14 6.23 1966 7.70 7.51 6.64 10.66 8.38 5.31 10.93 8.81 8.47 4.21 1967 6.72 3.62 5.85 6.73 6.82 5.35 8.87 5.52 8.15 5.05 Avg. 6.93 3.82 6.02 4.85 8.50 2.99 9.71 6.18 7.84 5.93 P = Parent Corporations; S = Subsidiaries. Table 6:9.--Rate of return on net worth of subsidiaries and parent corporations (Ownership-wise). (In percentage.) 10% to 25% 26% to 40% 41% to 50% 51% to 75% Above 75% n=8 n=5 n=4 n=6 n=4 Pa 5":1 P s P s P s P s 1963 8.00 7.01 8.96 -9.79 13.81 -0.84 12.38 7.77 10.65 17.65 1964 10.02 5.94 9.58 6.46 14.17 1.89 14.53 12.59 11.76 16.67 1965 10.54 8.51 10.36 13.46 14.79 8.28 15.39 12.45 12.26 14.07 1966 11.72 14.77 12.17 22.38 14.98 10.37 16.63 16.85 13.18 9.23 1967 10.41 8.16 10.53 12.31 11.60 9.40 13.91 10.92 12.65 10.39 Avg. 10.14 8.89 10.32 8.96 13.87 5.82 14.57 12.12 12.10 13.60 P = Parent Corporations; S = Subsidiaries. 209 Table 6:10.--Rate of return on total sales of subsidiaries and parent corporations (Ownership-wise). (In percentage.) 10% to 25% 26% to 40% 41% to 50% 51% to 75% Above 75% n=8 n=5 n=4 n=6 n=4 1963 5.49 5.01 6.75-17.70 7.15 7.80 7.87 7.59 7.71 6.24 1964 6.57 2.34 6.97 3.13 7.27 9.91 8.49 9.23 7.85 5.83 1965 6.24 7.34 7.28 14.44 7.36 1.79 8.94 7.00 «8.15 6.97 1966 6.57 24.39 7.88 25.91 7.01 8.07 8.93 10.64 8.39 4.95 1967 5.86 7.45 6.84 12.71 5.91 7.68 7.63 6.75 8.16 5.97 Avg. 6.17 9.31 7.14 7.70 6.94 7.05 8.37 8.24 8.05 5.99 P = Parent Corporations; S = Subsidiaries. Table 6:ll.--Rate of return on total assets of subsidiaries and parent corporations (Management-wise). (In percentage.) A11 U.S. Mag°glty 50%-50% Mlgoglty All Indian Directors Directors Directors Directors Directors n=3 n=9 n=4 n=9 n=2 Pa sa P s P s P s P s 1963 8.07 3.29 8.14 3.36 6.07 1.85 6.11 -1.04 7.47 5.38 1964 8.64 5.20 8.90 3.85 6.90 7.16 7.17 1.10 8.25 7.29 1965 8.94 8.20 9.00 4.69 6.77 8.40 7.28 4.34 10.19 4.38 1966 8.92 4.77 9.27 7.67 6.76 8.90 8.28 8.60 7.98 4.03 1967 8.21 4.25 7.57 6.06 6.08 5.69 6.95 3.52 8.24 3.86 Avg. .8.56 5.14 8.58 5.13 6.52 6.40 7.16 3.30 8.43 4.99 P = Parent Corporations; S = Subsidiaries. 210 Table 6:12.--Rate of return on net worth of subsidiaries and parent corporations (Management-wise). (In percentage.) Majority 50%_50% Minority A11 U.S. U S U S All Indian Directors Directors Directors Directors Directors n=3 n=9 n=4 n=9 n=2 Pa sa P s P s P s P s 1963 11.66 6.25 12.22 9.26 9.16 1.74 9.12 -1.05 9.29 15.03 1964 12.46 9.74 13.73 9.26 10.61 14.22 10.58 2.71 10.42 17.84 1965 13.21 13.15 13.98 10.25 10.75 14.99 11.36 9.48 13.03 11.29 1966 13.63 7.85 15.08 15.44 11.30 19.91 13.26 16.18 12.97 10.90 1967 12.44 6.55 12.04 15.07 10.54 11.15 11.61 6.12 12.00 8.28 Avg. 12.68 8.71 13.41 11.86 10.47 12.40 11.18 6.69 11.54 12.67 aP = Parent Corporations; S = Subsidiaries. Table 6:13.--Rate of return on total sales of subsidiaries and parent corporations (Management-wise). (In percentage.) All U.S. Magoglty 50%-50% Mlg°glty A11 Indian Directors Directors Directors Directors Directors n=3 n=9 n=4 n=9 n=2 Pa sa P s P s P s P s 1963 8.23 3.28 6.71 7.00 6.37 -4.33 6.75 -3.45 6.49 7.34 1964 8.32 4.04 7.40 10.60 6.94 9.00 7.21 -1.39 6.67 9.46 1965 8.63 6.85 7.55 4.84 6.99 10.32 7.56 10.56 6.02 5.64 1966 8.65 4.80 7.58 10.78 7.03 12.49 8.15 29.49 5.79 5.92 1967 8.23 4.61 6.49 10.29 6.19 7.95 7.02 7.53 6.14 6.01 Avg. 8.41 4.72 7.15 8.70 6.70 7.09 7.34 8.55 6.22 6.87 P = Parent Corporations; S = Subsidiaries. 211 than their parent corporations. The above analysis sug- gests that there is no evidence that the nationality of directors is of great significance. Size-Wise Comparison.--Tables 6:14, 6:15 and 6:16 give the rates of return on total assets, net worth and total sales respectively of the corporations. Table 6:14 indicates that the five-year average rates of return of U.S. subsidiaries falling in all the size groups were lower than their parent corporations. As compared to their parent corporations, the large-sized subsidiaries with total assets $8.36 million and above, earned relatively lesser five-year average rates of return than the small- sized U.S. subsidiaries. Table 6:15 reveals that the U.S. subsidiaries in size group between $8.36 million and $20.92 million were earning higher rates of return on net worth than their parent corporations. In other size groups, the parent corporations were earning more than their Indian subsidi- aries but the rates of return of the largest subsidiaries ($20.92 millions and above) were slightly less than their parent corporations. Table 6:16 indicates that the five—year average rates of return on total sales of the subsidiaries in size groups less than $2.08 million, between $4.20 million and less than $8.36 million, and $20.92 million and above, were greater than their parent corporations. In the other Table 212 6:14.--Rate of return on total assets of subsidiaries and parent corporations (size based on total assets).* (In percentage.) $2.08 and $4.20 and $8.36 and Leg: Egan less than less than less than $22592 and ' $4.20 $8.36 $20.92 0V9 n=7 n=2 n=5 n=7 n=6 Pa sa P s P s P s P s 1963 6.69 —0.40 9.25 3.86 8.73 -0.26 6.31 2.38 3.61 6.71 1964 8.13 1.26 10.31 4.91 8.72 -0.85 7.48 5.84 7.22 7.84 1965 8.62 6.97 12.14 4.44 8.69 0.62 6.43 7.00 7.27 6.43 1966 9.15 6.96 10.49 4.34 9.04 12.57 7.69 6.53 7.28 6.62 1967 8.18 5.10 9.79 3.39 7.07 4.61 6.60 5.62 6.30 4.10 Avg. 8.15 3.98 10.40 4.19 8.45 3.40 6.90 5.47 6.96 5.72 *In millions of dollars. aP = Parent Corporations; S = Subsidiaries. Table 6:15.--Rate of return on net worth of subsidiaries and parent corporations (size based on total assets).* (In percentage.) $2.08 and $4.20 and $8.36 and Leg: Egan less than less than less than $2§ggieand ° $4.20 $8.36 $20.92 n=7 n=2 n=5 n=7 n=6 Pa sa P s P s P s P s 1963 9.23 0.88 11.28 11.58 13.83 -0.06 9.19 6.20 10.60 7.00 1964 10.91 2.97 12.75 12.05 14.13 -2.42 11.05 14.52 11.98 15.86 1965 12.09 14.58 15.57 9.64 14.74 0.16 9.34 14.95 12.07 12.11 1966 13.82 13.04 15.63 10.12 15.05 23.53 12.39 13.98 12.83 13.76 1967 12.58 9.95 13.74 5.69 11.31 12.27 11.08 11.55 11.12 8.04 Avg. 11.73 8.28 13.79 9.82 13.81 6.70 10.61 12.24 11.72 11.35 *In millions of dollars. aP = Parent Corporations; 8;: Subsidiaries. 213 Table 6:16.--Rate of return on total sales of subsidiaries and parent corporations (size based on total assets).* (In percentage.) $2.08 and $4.20 and $8.36 and Leg: Egan less than less than less than $2§ggseand ° $4.20 $8.36 $20.92 n=7 n=2 n=5 n=7 n=6 Pa sa P s P s P s P s 1963 4.89 14.11 8.19 5.93 8.43 5.52 7.24 -0.88 6.80 3.62 1964 5.48 2.96 8.32 6.29 8.87 -5.06 7.91 5.54 7.13 14.59 1965 5.87 10.35 8.45 6.53 9.05 -0.10 7.45 9.93 7.31 9.67 1966 6.08 9 70 8.19 7.02 9.19 46.01 8.23 8.51 7.45 11.51 1967 5.62 7.55 8.24 6.54 7.53 13.44 7.15 6.96 6.61 6.03 Avg. 5.59 8.93 8.27 6.46 8.61 11.96 7.60 6.01 7.06 9.08 * In millions of dollars. aP= Parent Corporations; S = Subsidiaries. 214 size groups, the parent corporations earned more than their Indian subsidiaries. Tables 6:17, 6:18 and 6:19 give the rates of return on total assets, net worth and total sales respectively of subsidiaries on the basis of net worth size along with their parent corporations. Tables 6:20, 6:21 and 6:22 present the rates of return on total assets, net worth and total sales respectively of subsidiaries on the basis Of total sales size along with their parent corporations. The data of these tables do not indicate that in all the cases the larger subsidiaries were generally earning higher rates of return on total assets, net worth and total sales than the smaller subsidiaries. Minimum Rate of Return The above analysis indicates that the U.S. sub- sidiaries were earning smaller rates of return on invest— ment and higher rates of return on total sales than their parent corporations. But on the basis of the above infor- mation it is difficult to evaluate whether the parent corporations are satisfied with the performance of their Indian subsidiaries. To elicit this information, the parent corporations were asked to mention the minimum rate of return (excluding royalties, management fees and any transfer pricing at other than market rates) on net worth expected by them on their investment in India (Question 215 Table 6:17.--Rate Of return on total assets of subsidiaries and parent corporations (size based on total net worth).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg: Egan less than less than less than $5A§gvznd ° $1.05 $2.09 $5.23 n=3 n=4 n=2 n=12 n=6 Pa sa P s P s P s P s 1963 9.46 5.79 4.79 -0.81 6.64 1.36 7.32 1.28 6.71 3.61 1964 11.54 3.56 5.76 1.35 7.64 1.31 7.99 3.05 7.21 7.84 1965 11.16 7.19 8.23 6.19 9.12 5.66 7.36 4.34 7.26 6.43 1966 10.92 6.55 8.09 5.83 9.96 6.51 8.25 9.05 7.27 6.62 1967 8.91 5.30 7.80 4.37 9.46 4.54 6.80 5.20 6.30 4.10 Avg. 10.40 5.68 6.93 3.39 8.50 3.88 7.54 4.58 6.95 5.72 *In millions of dollars. a P = Parent corporations; S = Subsidiaries. Table 6:18.--Rate of return on net worth of subsidiaries and parent corporations (size based on total net worth).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg: Egan less than less than less than SSAfigvznd ' $1.05 $2.09 $5.23 n=3 ‘n=4 n=2 n=12 n=6 Pa sa P s P s P s P s 1963 13.29 14.36 6.25 0.28 8.62 5.74 11.12 3.59 10.59 7.00 1964 15.36 7.73 7.78 4.11 9.85 2.61 12.33 7.46 11.98 15.86 1965 15.35 15.00 11.36 13.85 12.14 10.47 11.59 8.79 12.06 12.11 1966 15.85 13.77 13.04 11.78 14.16 11.53 13.50 17.96 12.83 13.76 1967 14.25 12.40 11.95 6.80 12.49 8.31 11.18 11.85 11.12 8.04 Avg. 14.82 12.65 10.08 7.36 11.45 7.73 11.94 9.93 11.72 11.35 *In millions of dollars. a P = Parent Corporations; S = Subsidiaries. 216 Table 6:19.--Rate of return on total sales of subsidiaries and parent corporations (size based on total net worth).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg: Egan less than less than less than $5A§gv2nd ’ $1.05 $2.09 $5.23 n=3 n=4 n=2 n=12 n=6 Pa $3 P s P s P s P s 1963 6.70 14.11 4.32 4.37 6.66 7.49 7.73 -2.27 6.80 3.62 1964 7.47 3.05 4.63 7.62 7.03 -3.17 8.31 1.68 7.12 14.59 1965 7.26 7.30 4.85 11.91 8.41 7.98 8.11 5.75 7.31 9.67 1966 7.17 9.42 5.03 9.13 8.64 8.59 8.63 24.14 7.45 11.51 1967 6.49 10.25 5.13 5.32 7.92 6.96 7.31 9.66 6.61 6.03 Avg. 7.01 8.82 4.79 7.67 7.73 5.57 8.02 7.79 7.06 9.08 *In millions of dollars. aP = Parent Corporations; S = Sudsidiaries. Table 6:20.--Rate of return on total assets of subsidiaries and parent corporations (size based on total sales).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg; Egan less than less than less than ssifigvznd ' $1.05 $2.09 $5.23 n=7 n=l n=4 n=4 n=ll Pa sa P s P s P s P s 1963 6.39 -0.87 3.86 -0.50 9.74 -2.44 7.33 -0.99 7.00 5.39 1964 7.43 -0.66 3.60 -1.64 11.47 0.70 7.90 6.37 7.71 7.30 1965 7.68 3.70 3.36 0.36 11.52 6.08 8.27 7.96 7.29 5.98 1966 8.42 6.54 3.30 24.03 10.49 6.83 8.30 7.98 8.21 6.87 1967 6.89 4.15 3.44 2.00 8.31 4.79 7.17 5.66 7.51 5.14 Avg. 7.36 2.57 3.51 4.85 10.31 3.19 7.79 5.59 7.54 6.14 *In millions of dollars. aP = Parent Corporations; S = Subsidiaries. 217 Table 6:21.-—Rate of return on net worth of subsidiaries and parent corporations (size based on total sales).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg: Egan less than less than less than $5A§gvznd ' $1.05 $2.09 $5.23 n=7 =1 n=4 n=4‘ n=1l Pa 561 P s P s P s P s 1963 1964 1965 1966 1967 Avg. 9.29 0.70 10.66 -0.07 13.00 -4.28 10.07 -2.59 10.72 11.96 10.53 -1.12 9.89 -2.96 15.02 2.25 11.03 13.93 12.38 15.96 11.38 8.08 10.46 0.64 15.63 12.11 12.07 12.80 11.48 12.97 13.31 13.74 9.27 34.21 15.62 13.58 12.83 16.45 13.71 14.46 10.68 11.27 9.71 2.66 12.55 8.02 11.00 9.62 12.52 10.85 11.04 6.53 10.00 6.90 14.36 6.34 11.40 10.04 12.16 13.24 *In millions of dollars. aP = Parent Corporations; S = Subsidiaries. Table 6:22.-—Rate of return on total sales of subsidiaries and parent corporations (size based on total sales).* (In percentage.) $0.52 and $1.05 and $2.09 and Leg: Egan less than less than less than Sséfigvznd ° $1.05 $2.09 $5.23 n=7 n=1 n=4 n=4 n=ll Pa sa P s P s P s P s 1963 4.46 14.11 5.72 - 9.60-11.76 7.42 -6.03 7.21 6.38 1964 4.95 3.39 5.63-18.21 10.24 -6.77 7.73 15.70 7.75 9.22 1965 5.21 6.33 6.11 1.67 9.76 7.70 8.19 10.39 7.71 8.56 1966 5.53 10.24 6.23 33.50 9.70 19.03 8.39 14.01 8.17 9.39 1967 4.69 8.24 5.92 12.71 7.94 9.54 7.42 9.26 7.55 6.47 Avg. 4.97 8.50 5.92 5.93 9.45 3.55 7.83 8.67 7.68 8.00 *In millions of dollars. aP = Parent Corporations; S = Subsidiaries. 218 No. 7 of Appendix 1). Their response indicates that eight of the fourteen parent corporations expect to get above 15% rate of return; three corporations mention that they expect above 10% whereas another three corporations do not have a definite rule regarding the minimum rate of return. No parent corporations expect 5% rate of return on net worth from its subsidiary. Table 6:23 gives the details. Table 6:23.--Minimum rate of return acceptable by parent corporations on net worth. Number Rate of Return . of Companies (1) Above 20 percent 4 (2) Above 15 percent 4 (3) Above 10 percent 3 (4) Above 5 percent - (5) No Definite Rule 3 Total 14 A comparison of actual rate of return and the ex- pected minimum rate of return on net worth of the U.S. subsidiaries6 would give some insight regarding the 6The minimum rate of return as suggested by the parent corporations does not take into account the price level adjustment. Moreover, this is annual rate of return expected by the parent corporation. The five-year average 219 individual performance of the subsidiaries. Table 6:27 gives the details of the five-year average rates of return of individual subsidiaries which were earning more than their parent corporations. The data indicate that there were four subsidiaries earning more than a 15% rate of return on net worth. Another seven subsidiaries earned more than 10% rate of return on net worth. This suggests that only 41% of the subsidiaries were able to meet the minimum rate of return expected by 80% of the parent corporations. It is striking to note that one parent corporation was earning above 15%; seven parent corporations were earning above 10% and not a single parent corporation was earning above 20% rate of return on net worth. In other words, out of 27 parent corporations, only eight corporations were earn- ing above a 10% rate of return on net worth as against eleven subsidiaries earning above a 10% rate of return. The above discussion may give the impression that the Indian subsidiaries could not meet the expectations of their parent corporations. Such a conclusion would not necessarily be realistic because the subsidiaries, while earning lower five-year mean rates of return on total assets and net worth than their parent corporations, at the rates of return as computed for the present study take into account the price level adjustment. Moreover, these rates are the average rate of return. Despite these differences, the comparison would provide some rought idea regarding their performance. 220 same time earned higher rates of return on total sales than their parent corporations. This indicates that the subsidiaries were able to eXpand their product market in India and earn higher rates of return on total sales. As has been pointed out earlier, the U.S. corporations empha- size the expansion of their subsidiaries' markets and so long as they are able to do that, the lower rates of return on their investment do not greatly concern them in the short term. However, the rates of return on net worth of subsidiaries on the basis of their age groups substan- tiate their well-planned approach. The well-established subsidiaries were earning higher rates of return on net worth than their parent corporations (see Table 6:6). It indicates that with the passage of time, the subsidiaries may be able to earn higher rates of return on investment than their parent corporations. This pattern or strategy is further substantiated by the parent companies' response to the question of whether the performance of their subsidiary in India lived up to their expectations (Question NO. 13 of Appendix 1). Approximately two-thirds of the parent corporations pointed out that the performance of their subsidiaries was reason- able considering the economic situation Of India. One corporations mentioned that the performance of Indian sub- sidiary exceeded the expectation. As against this one-fifth of the parent corporations felt that the performance of 221 their Indian subsidiary was disappointing. One parent corporation was very much disappointed with the result of its Indian subsidiary. Table 6:24 gives the details. Table 6:24.--Expectation of parent corporations regarding the performance of their Indian subsidiaries. . Number Expectation Of Companies (1) Reasonable in early period 9 (2) Disappointed today 3 (3) Exceeded l (4) Very disappointed l (5) Early to judge - Total 14 Beside the above attitude, the parent corporations have also expressed their views regarding future programs of their Indian subsidiaries. Their positive or negative attitudes would reflect their views regarding the perfor- mance of their Indian subsidiaries. Table 6:25 gives the details of their attitudes regarding future investment in India (Question NO. 12 of Appendix 1). Half of the parent corporations expressed their willingness to expand the operation of their Indian sub- sidiaries; one-fifth of the parent corporations expected to maintain the present level; and the remaining parent 222 Table 6:25.--Attitudes of parent corporations regarding future investment in India. .‘ Number Expectation of Companies (1) To expand the Operation 7 (2) To maintain present level 3 (3) To reduce present level — (4) Uncertain 4 Total 14 corporations were uncertain regarding their future in- vestment in India. It is striking that no corporation is planning to reduce the present level operation of its Indian subsidiary. During the course of personal interviews, the executives pointed out that their corporations realized that, in view of the adverse Indian economy during the period under study, it was difficult for their Indian subsidiaries to earn higher rates of return. Despite this situation, the parent corporations were not disap- pointed with the performance of their Indian subsidiaries. Many Of them emphasized that their corporations had either expanded the existing Operation in India or had already started a new subsidiary in India. These actions on the part Of the parent corporations demonstrate their satis- faction with the performance of their Indian subsidiaries. 223 PART II Business Risk The term 'business risk' refers, in the present study to the variability of the past rates of return on total assets, net worth and total sales. The variability of the rates of return means the dispersion in the rates of return. This risk rationale may be illustrated with the help of the following example. Suppose there are two investments 'A' and 'B' and both of them earn a mean rate of return of 10% over a five-year period. Investment A's annual rate of return in each year is fairly consistent whereas investment B's annual rate of return is fluctuat- ing widely. In other words, though the mean rate Of re- turn is the same, there is vast difference in the vari- ability of the measurements about the mean for the two investments. A rational investor, given the choice, would prefer investment A than investment B because there are greater uncertainty in the case of latter than the former.7 Measurement of Variability There are numerous measures of variability. Among these, the range, quartiles and percentiles, variance and standard deviation are considered to be the most important 7For details see, J. Fred Weston and Eugene F. Brigham, Managerial Finance, op. cit., pp. 215-19. 224 8 For a number of reasons for the measures of variability. which are complex and need not be discussed here, the most generally accepted measure is the standard deviation. Thus the variability is measured by standard deviation from the mean return of each company for the five-year period (1963-67). The standard deviation is calculated 4 by using the following formula: n _ 2 ‘ {(Yi-Y) ~ i=1 S = n - l where is standard deviation, U) is arithmetic mean, is the set of measurements of Yi,Y2, ..... Yn, u>+< NI (Yl-Y) is the square Of the deviation of a measurement from the mean, and n is the number of cases. With the help of the above formula, the standard deviations of the rates of return on total assets, net worth and total sales of subsidiaries and parent 8William Mendenhall, Introduction to Probability and Statistics, (Belmont, California: Wadsworth Publish- ing Company, Inc., March, 1969), pp. 29-42. 9Harry M. Markowitz, Portfolio Selection (New York: John Wiley & Sons, Inc., 1959), pp. 294-97. 225 corporations on individual basis were calculated. The greater the standard'deviation, the greater the Variability of return by definition, the greater the business risk. It is possible that the higher rates of return may be associated with higher business risk or the lower rates Of return may be associated with lower business risks. To evaluate the business risks associated with the higher and lower rates of return of subsidiaries, the business risks are studied in two parts, i.e., business risk of higher return subsidiaries and business risk of lower return subsidiaries. Business Risk of Higher Return subsidiaries Tables 6:26, 6:27 and 6:28 present the information regarding the variability of returns of subsidiaries with rates higher than their parent corporations. Table 6:26 indicates that with the higher rates of return on total assets of subsidiaries, the variability was also greater than their parent corporations. The standard deviation of subsidiaries varied from 2.0 to 7.6 as against a variation of 0.3 to 2.0 for the parent cor- porations. Thus the business risks of the subsidiaries were relatively greater than their parent corporations (Fig. 6.2 shows this picture). Table 6:27 shows that there were eleven subsidi- aries which were earning higher rates of return on net 226 .mmum OHQMB so pmmmm “mousom .mcowumuomuoo ucmumm cam Aumnmflnv mOHMMHOHmOsm mo muommm Hmuou co cusuwu cam memII.N.m wasmflm Ammmusmoumm :Hv cusumm mo mumm 4m om ma NH m 4 o _ C _ _ i — O .6 In re 322333 © msofiumuomuou ucmumm x .lm enae 227 Table 6:27.--Higher mean rate of return on net worth and standard deviation of subsidiaries and their parent corporations. Mean Rate Of Returna Standard Deviation Parent/ ~ ° * SubSidiary Parent Subsidiary Parent Subsidiary 1. X3 10.8 12.1 1.1 10.1 2. X5 13.8 16.6 1.9 2.9 3. X10 10.1 14.1 2.6 9.8 4. X11 10.1 14.1 1.6 9.7 5. X13 6.6 11.1 1.8 3.5 6. X16 15.1 24.7 1.0 7.2 7. X17 10.1 10.3 0.8 16.8 8. X20 7.1 10.7 2.7 3.8 9. X21 9.1 12.5 3.1 9.4 10. X22 10.2 16.4 0.9 5.6 11. X25 14.9 15.1 2.9 6.0 * These are the number of subsidiaries (11) paired with parent corporations having higher mean rates of return on net worth than their parent corporations. aIn percentage Table 6:26.--Higher mean rate of return on total assets and standard deviation of subsidiaries and their parent corporations. Parent/ Mean Rate Of‘Returna Standard Deviation Subsidiary* Parent Subsidiary Parent Subsidiary 1. X2 3.5 4.9 2.0 7.6 2. X10 3.9 6.7 0.3 4.6 3. X13 3.2 3.5 0.8 2.0 4. X17 6.1 8.7 0.3 5.6 5. X20 3.1 5.8 1.5 2.1 6. X21 5.2 7.0 1.1 4.8 * These are the number of subsidiaries (6) paired with their parent corporations having higher rates of return on total assets than their parent corporations. aIn percentage. 228 worth than their parent corporations. The standard de- viations of subsidiaries were varying between 2.19 to 16.8 as compared to 0.8 and 3.1 for the parent corpora- tions. Moreover, the variability of the rates of return of each subsidiary was relatively greater than parent corporations (Fig.. 6.3 depicts this picture). Table 6:28 reveals that the standard deviations of subsidiaries were varying between 1.6 and 14.6 as com- pared to 0.2 and 1.4 in the case of parent corporations. The business risk of each subsidiary was relatively greater than its parent corporations. (Fig. No. 6.4 shows this picture.) From the above analysis, it is evident that the business risk of all subsidiaries with higher rates of return is greater than their parent corporations. The lower variability of parent corporations may be due to the fact that the parent corporations are generally older, have more regularized and diversified processes and trade channels, and perhaps are more particular in choosing ac- counting methods to achieve income smoothing. The fluctua- tion in economic situation of India appears to have greater impact on the variability of rates of return of subsidiaries. Business Risk of Lower Return Subsidiaries Tables 6:29, 6:30 and 6:31 present the data regard- ing the variability of returns of subsidiaries with rates lower than their parent corporations. 229 Risk l4