Global Currency Unit or GCU
Global Currency Unit or GCU
There seems to be a growing consensus that for an enterprise to function as a truly multinational enterprise a global perspective is needed. The question, however, has been raised whether a truly global perspective can prevail and be maintained when reports, budgets and performance evaluation systems are primarily denominated in a currency that lacks global perspective, being it the domestic currency of the parent, the local currency of the subsidiary, or both. The performance evaluation system should direct the subsidiary managers´ as well as headquarters managers´ efforts towards worldwide goals. This may prove to be difficult when the performance evaluation system is nationalistic in nature because of its currency denomination. For example, in U.S. MEs decision making by boards of directors and headquarters management is generally based upon U.S.-dollar information. Morsicato (1981) asserts that many high echelon managers do not understand how to interpret subsidiary results reported in local currency. If one level of management bases their decisions upon U.S.-dollar information and another level upon local currency information, problems with goal congruency and optimization of resources may rise. Therefore further attempts towards developing goal congruent multinational performance evaluation systems are needed (Morsicato, 1981). The creation of a Global Currency Unit (GCU) may be a step towards better performance evaluation systems.
The currency denomination alternatives for performance evaluation actually used and discussed have been the currency of the parent company, the local currency of the subsidiary, or both. The GCU offers a totally new perspective and dimension. The GCU can be defined as a currency that would appropriately take into account each part of the ME´s operations and activities in an unbiased and non-nationalistic way. It is a currency that would be a conglomerate or hybrid of the different currencies relevant to the ME. In this respect it bears resemblance to the European Currency Unit (ECU).
The major advantage of using a GCU is that it offers the ME a truly global perspective. The importance of developing a global strategy and maximizing results on a multinational basis has been emphasized by both business managers and academics in ME-related articles, presentations and discussions. One aspect, however, has been left out or forgotten from the discussion about a global perspective, namely that developing a GCU is possibly a prerequisite for achieving truly global thinking. The use of a GCU would actually force the management of headquarters as well as the management of the foreign subsidiaries towards global thinking. This is not the case when headquarters management of MEs bases its decisions upon parent currency information, which seemingly is the general practice in U.S. MEs. Preparing budgets and standards in a GCU would force the management of the constituent parts of the ME into global thinking. Subsidiary managers would be more apt to accept a performance evaluation system denominated in a GCU than a system denominated in the parent´s currency because they would be more assured that headquarters management actually is aiming for global objectives rather than predominantly parental objectives. Furthermore, the use of a GCU would provide a certain uniformity throughout the ME organisation. A consequential positive effect on behavior and performance could be expected.
Another advantage of a GCU would be the smoothing effect it would have on budgets and reported results, that is, the impact of exchange rate fluctuations on performance evaluation would be reduced. If financial data is translated from a weak and unstable foreign currency into a strong parent currency, the result of the translation is extensively going to be affected by the exchange rate changes. A GCU, on the other hand, represents a sort of average currency in that its value falls somewhere inbetween the extremes of a weak and a strong currency. A decline in the value of the weak currency would be less extensive in relation to the GCU than to a possibly strong parent currency. In addition, the GCU would be more stable than the other currency units of the ME because it is a composition of the other currencies which means that adverse fluctuations in the other currencies would tend to even out when incorporated in the GCU.
How would a ME construct its GCU? The construction of the GCU would be similar to the construction of the ECU. The ECU is a basket of 12 currencies. These are the German mark, French franc, British pound, Italian lira, Dutch guilder, Belgian franc, Spanish peseta, Danish krone, Irish punt, Portugese escudo, Greek drakma and Luxemburg franc. The last one is of little economic significance in determining the value of the ECU. The ECU is an integral part of the European Monetary System (EMS), popularly called the 'snake'. In the original construction of the ECU it was necessary to establish weights for the different currencies to be included. The weights were fixed as of June 30, 1974 on the basis of certain economic criteria. These criteria were the average Gross Domestic Product (GDP) of 1969-1973, that is, the preceding five years, and the internal trade within each member country. The weights assigned to each currency on June 30, 1974 as well as the weights assigned in connection with the most recent realignment, that is, on October 8, 1992 are displayed in Table 1. The Spanish peseta, Portugese escudo and Greek drakma were not part of the original ECU because Spain, Portugal and Greece were not European Community members in 1974. The composition of one ECU as it was established in 1974 is shown in Table 2. To express the value of the ECU in one of the national currencies some calculations are needed. As an example, the calculation of expressing one ECU in French francs is illustrated in Table 3.
As can be seen from Table 1, the weight of the German mark has clearly increased from 1974 to 1992 showing that the German economy has strengthen as compared to the other European economies. Originally one ECU was equal to one U.S. dollar. Today one ECU is clearly more than one dollar showing that the economy of the European Community taken as a whole has strengthen in relation to the American economy since 1974. The main factor behind this development is the German mark and in that respect the development of the German economy. The German economy is clearly the dominant economy within the European Community. The recent turbulence in the currency exchange markets has also put the European Monetary System and consequently the ECU under pressure. Keeping relatively fixed exchange rates when national economies develop in different directions may not be realistic if realignments are not carried out sufficiently often and if the adjustments made are too small. The realignments of exchange rates are too much affected by political compromises and therefore newly established exchange rates may not sufficiently reflect underlying economic facts. The market of the ECU has extensively developed since the conception of the ECU. Today the market of the ECU offers basically the same services as the markets of all the other EMS currencies. Several companies publish their financial statements in ECUs. The French Saint Gobain is an example of this. The ECU is not the only currency composite of importance today but there is the Special Drawing Right (SDR) of the International Monetary Fund. The SDR consists of the U.S. dollar, Japanese yen, German mark, French franc and the British pound.
Table 1: The weights of the ECU currencies
30.06.1974 08.10.1992
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German mark (DEM) 27.3% 31.76%
French franc (FRF) 19.5% 19.98%
British pound (GBP) 17.5% 11.11%
Italian lira (ITL) 14.0% 8.68%
Dutch guilder (NLG) 9.0% 9.94%
Belgian franc (BEF) plus -- 8.16%
Luxemburg franc (LFR) 8.2% --
Spanish peseta (ESP) -- 4.93%
Danish krone (DKK) 3.0% 2.60%
Irish punt (IEP) 1.5% 1.15%
Portugese escudo (PTE) -- 0.80%
Greek drakma (GRD) -- 0.58%
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100.0% 100.00%
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Sources: Lefevre (1985), and Kauppalehti (January 22, 1993)
Table 2: The composition of one ECU (1974)
1 ECU = 0.828 DEM
+ 1.15 FRF
+ 0.0885 GBP
+ 109.0 ITL
+ 0.286 NLG
+ 3.66 BEF
+ 0.217 DKK
+ 0.00759 IEP
+ 0.14 LFR
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Source: Lefevre (1985)
Table 3: Calculation of the ECU rate, expressed in FRF as of July 25, 1983
Currency Amount of currency Exchange rate in FRF Equivalent value in FRF
(a) (b) (a) x (b)
DEM 0.828 3.0067 2.4895
FRF 1.15 1.0000 1.1500
GBP 0.0885 11.9175 1.0547
ITL 109 0.005084 0.5542
NLG 0.286 2.6877 0.7687
BEF 3.66 0.150445 0.5506
DKK 0.217 0.8348 0.1812
IEP 0.00759 9.4960 0.0721
LFR 0.14 0.150445 0.0211
Rate of ECU in FRF 6.8421
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Source: Lefevre (1985)
The basket of currencies in constructing the GCU would consist of the currencies relevant to the ME´s operations. In many instances it may be practical to leave out currencies which play a minor role in the ME´s operations (compare Luxemburg franc in the ECU). The currencies relevant to the ME´s operations may be determined on the basis of the ME´s sales in each currency, market share in each currency region, actual commitment in form of assets in each country (currency), actual costs incurred in each currency, or a combination of these. The most appropriate way of determining which currencies to include in the currency basket of the GCU may be to apply the functional currency concept as presented in the Statement of Financial Accounting Standards No. 52. "An entity´s functional currency is the currency of the primary economic environment in which the entity operates; normally that is the currency of the environment in which an entity primarily generates and expends cash" (Financial Accounting Standards Board (FASB), 1981). FASB lists some economic factors or indicators, which should be considered both individually and collectively in determining the functional currency. These are cash flow indicators, sales indicators, expense indicators, finance indicators, and intercompany transactions and arrangements indicators. A more detailed clarification of these indicators is presented in Appendix A. FASB does not, however , exclude the use of other possible economic indicators than the ones listed.
Once the currencies of the basket have been selected the initial weights of these currencies have to be determined. The weight of each currency in the basket would be based on its proportional representation within each category of the selected economic indicators. For instance, if sales are used as one economic indicator the average sales figure within each currency for the preceding three to five years could be used as a basis. In establishing the initial weights for the ECU, the average GDP for the preceding five years was the dominant economic factor used. Each ME must independently determine which economic factors to consider in assigning the weights to the currencies of its GCU.
The representation of currencies and their corresponding weights within the GCU may be kept unchanged once determined until substantial changes in the ME´s operating environment occur. If such changes alter the significance of a currency within the GCU or add a currency of great importance to the ME´s environment and operations, the representation and weights of the GCU should be adjusted accordingly. Adjustments would specifically be needed in newly internationalized enterprises which are in their first stages of becoming multinational. Adjustments of weights are not desirable for small changes in the relative significance of currencies because stability and clarity of the system are desirable. Even if the representation of currencies and initial or basic weights remains unchanged for a period the so-called 'effective' weights change regularly according to the changes in the exchange rates of the currencies within the GCU, exactly the same way as exchange rate changes are incorporated into the ECU.
The number of currencies to include in the GCU cannot be too high because the manageabilty and clarity of the GCU system would suffer. A number between the number of currencies within the SDR and ECU, that is, five to twelve may be suitable. If desired, a ME can construct different GCUs for different economic regions such as the European Community, North America, ASEAN countries, and so on. A system similar to the EMS is naturally not behind a GCU. This means that the exchange rates of the GCU currencies are not managed the same way as within the EMS (if not an ECU currency) but fluctuate to a greater extent. Consequently, the GCU would fluctuate more than the ECU. The GCU, however, would fluctuate less than the the individual currencies of the GCU.
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