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PART II: Segmentation Issues

Consolidation and segmentation

Calls for corporate glasnost have drawn attention to conflicting disclosure agendas. One of these conflicts involves the trade-off between more information about the corporation as a whole and increased transparence of individual segments. The corporation is seen either as an integrated economic entity or as an organizationally differentiated, industrially diversified and/or geographically dispersed confederation.

Proponents of information consolidation point to the inappropriateness of external scrutiny of the performance of individual segments and to the complexity of information for non-expert constituents interested solely in the company as a whole (Gray 1984). Segmentation may disconnect items of information, rendering comprehension difficult and creating the potential for information overloads. Segmentation may also disconnect stakeholders, making it arduous for them to communicate and to learn about other claims to corporate resources.

Consolidation, however, eliminates information detail needed by experts (e.g. financial analysts) or by segment- specific constituents who are interested in limited, 'high- resolution' information. Fans of segmentation see corporate components interact with, or be accountable to, compartmentalized environments and constituents with different information needs.

Firms would wish to avoid excessive segmentation, if more and detailed information threaten the very benefits of organization (Williamson 1989). In this transaction cost view, the rationale for organization is based on the net- gains from reduced external communications and increased internal coordination. Disclosures necessitating information systems beyond those internally required and routinely maintained reduce these organizational economies (Table 3).

Table 3. Segmented and consolidated information: Stakeholder interests


In-Toto Stakeholders Segmental Stakeholders (e.g. investors) (e.g. local communities)
Realization that Interest in local Segmented overall performance corporate conditions Information of firm depends on and impacts segmental performance
Consolidated "Bottom line" Recognition of Information mentality Interdependencies (e.g.unitary taxation, Vredeling Proposal)

Other arguments have been fielded against segment disclosures ( Belkaoui 1988; SEC 1977). Segmented information might encourage hostile takeovers by assisting raiders in identifying the potential market value of disposable corporate segments. There also is the problem of "jointness" of data combining functions serving more than one organizational segment. Accounting principles for internal allocation may differ from outsiders' preferred allocation. The problem exists not merely for cost, earnings and other performance measures, but also for the allocation of administrative employment, wage and salary payments, and for supply or market linkages serving more than one product line or location. Blanpain (1985), for example, complains that calls for a financial disclosure requirement on a country-by-country basis in the annual report of a MNE ignore both the complexity of such an exercise and the limited value of the resulting information. Accounting standards stress that (geographically and otherwise) segmented information "is intended primarily for the purpose of assessing the performance and financial position of the enterprise as a whole and is unlikely to be fully comparable with segmentated information of other enterprises" (Blanpain 1985, p.36c). Of particular concern is the segmental allocation of corporate (headquarter) overhead costs and revenues. In light of the diversity of possible allocation methods, Blanpain suggests that any detailed geographically segmented disclosure requirement would create considerable confusion and misinterpretations.

Similar conflicts between the information needs of financial investors and those of other stakeholders become evident from a closer look at various consolidation mandates and proposals. The principle accounting standard governing consolidation practices in the US is represented by the Accounting Research Bulletin 51, "Consolidated Financial Statements". Here, we find a reference to the presumption "that consolidated statements are more meaningful than separate statements and that they are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies" (quoted after Ernst & Whinney 1987, p.4). In a more specific vein, Ernst & Whinney's (1987, p.ii) introduction to a proposal by the Financial Accounting Standards Board (FASB) states: "The FASB wants full consolidation mainly because of the increasing diversity of corporate business. Because of this diversity, it believes consolidation of all subsidiaries will improve consistency and completeness in financial reporting."

Consolidation also supports other preferences for secrecy; "...suppliers, employees, customers and foreign governments would use the figures to extract concessions from the company and .. competitors would use the information to invade the (company's) profitable markets" (SEC 1977, p.383). By the same token, the parent corporation may have an interest in disclosing the poor performance of a local unit in order to avoid excessive local claims against non-local corporate resources. Transfer pricing and unitary taxation practices represent related issues. Similar conflicts may arise when corporations simultaneously cooperate and compete. A breach of competitive secrecy may result from the need to share information to assure cooperation (Bresser 1988).

There are other (marketing, political, good will) motivations for geographically more detailed disclosures. Firms want to release good information but withhold bad news (Diamond 1985); good news improve the evaluation of the firm by investors or other stakeholders which, in turn, may impact the manager's compensation (Trueman 1986) or social status in the community. If management yields to this lure, the better performing facilities will more often be highlighted. Laulajainen (1987) found that small and/or young department store firms were proudly disclosing facts about individual stores and the addition of outlets. However, larger chains, for whom the detailed descriptions become unwieldy, tend to downplay location-specific information.

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Stakeholder perspectives -- Corporate constituents may also have an interest both in consolidation or segmentation, but generally for opposite reasons. Consolidation helps to reveal the overall performance and global resources of the corporation, knowledge which tends to be appreciated, for example, in local collective bargaining. Segmentation, on the other hand, may assist the community in understanding the operations of regional plants, their productivity, problems, and opportunities, thereby making it more difficult for the corporation to justify or to hide resource transfers to other locations. Proponents of segmented information suggest that consolidation plays into the hands of secrecy- minded executives by obscuring internally differentiated performances. Thus, it would be in the interest of the community to have access to both consolidated and segmented information inasmuch as the combination of the two helps to "connect" information.

Given that a growing corporation will ultimately tend to issue stocks and thereby subject itself to mandatory financial disclosures, it can also be argued that growing economic concentration, internationalization and organizational interdependence extend physical, political and organizational distances between local facilities and corporate headquarters (HQ) and reduce the visibility of local corporate activities to local stakeholders. Thus, local comprehension of the totality of the corporate system and of the role of local facilities in this system will tend to deteriorate. Therefore, it would be no contradiction to favor both more segmented and more consolidated information. Indeed, more information covering intermediate organizational and geographic levels would assist local stakeholders in reconnecting local and HQ level information.

The cost of providing both segmented and consolidated information will depend in part on the structure of the organization. For highly centralized and/or integrated firms, segmented performance information, beyond what is needed for control and accounting purposes, could be costly. Such information may also be of mere historical value to stakeholders, since HQ's plans and intentions for specific segments may have little to do with past performance. Consequently, segmented corporate plans and forecasts would be more useful for segment- oriented stakeholders. Constituents of decentralized, polycentric firms, on the other hand, may find segmented historical performance information a more reliable indicator of what is to come and also would have relatively little use for consolidated information.

This discussion of informational segmentation is influenced by the accounting views of financial disclosure in MNEs. Yet, disclosure segmentation is becoming much more of a geographic theme in the context of social and environmental issues. Plant- and locality specific information is important for collective bargaining, social reports, employment projections, occupational planning, training and health contexts, and a variety of environmental concerns. The fact that many segmented disclosure mandates and voluntary practices are already in place in industrialized countries has to be kept in mind when questioning the emphasis given to consolidated information disclosure by the (EC) Vredeling proposal, in the (EC) Seventh Directive on Consolidated Accounts or in the OECD Guidelines for Multinational Enterprises ( Blanpain, 1985; Emmanuel et al. 1988; Streeck, 1997)

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Segmentation of "soft" information -- Inasmuch as corporate disclosures affect constituents' own plans, there ought to be a strong interest in information related to the corporation's assessments of future opportunities, plans to exploit such opportunities and prediction as to the implications of such plans for the performance of the corporation or its components, that is in "soft" information. Most of the attention has been focused on the prudence of disclosing short-term earnings forecasts. Supporters argue that performance estimates will assist shareholders' allocation decisions and thereby lead to more efficient capital markets; moreover, the danger of uneven disclosure benefiting some at the expense of other investors would best be countered by timely and full disclosure. On the other hand, there are those who argue that, without equal access to the underlying premises or equal ability to evaluate their significance, users are too easily mislead (SEC 1977). Fear of liability for damages resulting from wrong or misleading forecasts has discouraged such disclosures. Not surprisingly, it was found that firms with more volatile performances are less likely to disclose their internal forecasts (Waymire 1985).

Other suggestive findings relate to enhanced predictability of corporate performance through disclosure of segmented information ( Hopwood et al, 1982; Scherer 1979). Studies of data use by financial analysts have led to the conclusion that "segment reporting allows the majority of analysts to improve their predictions and their confidence about those predictions" (Emmanuel et al. 1988, p.282). However, many segment-oriented constituents are likely to be more interested in performance forecasts for individual segments in their own rights. This applies particularly to geographically segmented constituent groups given the interests of planners and policy makers in such forecasts. It would seem that the disclosure of projected local investments, product developments, process innovations or employment changes would be particularly useful for local, non-investor constituents.

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Segmentation -- Geographic Perspectives

While local or regional stakeholders are primarily interested in geographically explicit disclosures, other forms of segmentation may also be of value. Disclosures by legal entities, organizational divisions, "lines of business", or classes of customers are more frequent and can yield geographic insights for alert constituents able to merge such information with independent knowledge of corporate location patterns. Nevertheless, the overall usefulness of segmented disclosures is limited by the fact that the purpose of most cases of segmentation (e.g. in annual reports) is to improve the information detail for the investor who has a stake in the company as a whole and not for the regional constituent (such as governments or labor unions).

It is not surprising, therefore, to find segmentation rules which serve to simplify the evaluation of the whole. In the United States, for example, a reportable corporate 'segment' is defined by the Financial Accounting Standards Board (FASB) as one which represents more than ten per cent of the consolidated total (revenues, operating profit or loss, and identifiable assets appropriate to foreign operations) for the enterprise as a whole. More specifically, FAS 14, paragraph 34, states: "Each enterprise shall group its foreign operations on the basis of the differences that are most important in its particular circumstances. Factors to be considered include proximity, economic affinity, similarities in business environment, and the nature, scale, and degree of interrelationship of the enterprise's operations in the various countries" (after Prodhan 1986, p.43).

It is evident that for large MNEs even ten geographic segments would not reveal much useful information. Nevertheless, an authoritative text on international accounting suggests that even investors might become more sensitive to the geographic detail of their risk exposure: "While researchers have not studied the question as it relates to financial data disaggregated by geography, it stands to reason that such information might also improve investors' predictions. After all, not all areas of the world have equally risky business environments or present equal business opportunity" (Mueller et al. 1987, p.59).

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Geographic segmentation practices -- Empirical studies confirm that corporate annual reports and the regionalizations used in such disclosures do not provide much geographic detail which might be of interest to noninvestor constituents. Gray and Radebaugh (1984) found that only 31% of Fortune 500 firms provided geographic analyses of new investment activities, while only 10 firms disclosed geographic employment patterns. Moreover, regionalization criteria, including criteria for the scale of geographic segments, are diverse and include: (i) the significance of an area's contribution to the total company's performance; (ii) the coincidence with legal entities within the group; (iii) the need to avoid the host government's or other regional stakeholders' scrutiny; (iv) the need to disguise dependence on politically unstable markets (Emmanuel & Garrod 1987, p.237).

In the empirical part of Emmanuel and Garrod's study of six U.K. companies with world wide operations, the number of geographic segments varied between three and six. This author's analysis of 12 mainly European corporations belonging to the oil, steel, chemical, electrical/electronics and banking industries shows a range from 4 to 8 regions (Table 4). In most cases, geographic segments coincided with continents or were recognized on the basis of countries of corporate origin, countries of primary corporate involvement or economic blocs of countries. However, definitions varied greatly consistent with well-known geographic ambiguities of global and continental regiona]izations. Australia and Asia have particular identity problems. The absence of any agreement on a region dominated by Japan is striking but explained by the European bias in the sample and by the fact that foreign firms have generally not yet been able to establish significant operational footholds in Japan. One would also expect that the redrawing of the European map and economic change in Eastern Europe will create additional regionalization ambiguities.

Sales volumes dominate the data disclosed on a regional basis. However, several firms release employment, gross income levels and, in the case of Royal Dutch N.V. Koninklijke Nederlandsche Petroleum Maatschappij, even profit figures and tax payments by regions. Royal Dutch N.V. also disaggregates the total crude oil production of the Royal Dutch/Shell group of 5.7 million barrels per day (1988) by (in %)

  • "Europe" (28.3),
  • "Africa" (12.2),
  • "Middle East" (23.7),
  • "Far East and Australasia" (6.0),
  • "USA" (22.7),
  • "Canada" (3.7),
  • "Remainder of Western Hemisphere" (3.4).

Among other regional data, there is also information on the nationality of stockholders, ranging from Great Britain (40%) down to Belgium holding 1% of the stocks. The diversified West German steel corporation Mannesmann AG discloses its total DM 22.3 billion sales volume for the following markets (in %, for 1989):

  • "FRG" (36.4);
  • "Other EEC Countries" (21.3);
  • "Rest of Europe" (13.6); "Africa" (3.8);
  • "Asia" (6.0);
  • "North America" (10.1);
  • "Latin America" (7.9);
  • "Australia and Other Regions (.9).

Siemens AG segments regional information only for revenues and investments; the following regionalization is used (% of total investments for 1987/88):

  • "FRG" (54.6);
  • "Europe without FRG" (20.7);
  • "North America" (18.8),
  • "Latin America" (3.6);
  • "Asia" (1.6),
  • "Other Regions" (.7).

Siemens' major European competitor, Philips, is geographically slightly more articulate. It publishes "deliveries" and gross income figures for the following regions (% of value of deliveries, including intra-corporate deliveries, for 1988):

  • "Netherlands" (21.7);
  • "Rest of Europe" (46.3);
  • "USA and Canada" (16.6);
  • "Latin America" (4.2);
  • "Africa" (.8);
  • "Asia" (9.2),
  • "Australia and New Zealand" (1.2).

Like many other firms, Philips publishes sales and income data also by line of business, however without further geographic disaggregation.

While many firms disclose their external markets, few identify any geographic dimensions of their i n t r a - corporate trade. 43% of 1979 Fortune 500 corporations did not even disclose their aggregate intra-enterprise sales (Gray & Radebaugh 1984). Due to the increasing importance of such global, non-market interdependencies, this lacuna frustrates many constituents.

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Segmentation and the Unitary Taxation Debate

A case in point involves the "unitary taxation" of income of firms operating in multiple jurisdictions. Intra-corporate and inter-affiliate trade has become a significant part of the international trade scene. For the U.S., such trade accounts for approximately 40% of all exports and imports (Little 1987). For individual corporations, these percentages can be much larger. There are many opportunities to price such transactions so as to shift income into low- or no- tax jurisdictions (Dunning 1988). Thus, tax collectors need consolidated data to "recalculate" regional segments' fair share of total (unitary) corporate assets, sales, earnings or profits.

In the U.S., where most states collect their own corporate income tax, unitary taxation has long been an issue ( Rothschild 1986; Wasson & Weigand 1988). Apportionment methods and formulae vary from state to state in terms of (i) weights given to property, payroll and sales; (ii) the inclusion of income of subsidiary or holding companies (rather than just the parent) and worldwide (rather than just domestic) operations. Corporations frequently claim that a worldwide combination is not just an accounting nightmare, but may also lead to tax inequities and double taxation. "A unitary tax is extraterritorial; the state claims a right to tax profits earned, property owned, or some other aspect of operations that occur hundreds or even thousands of miles away" (Wasson & Weigand 1988, p.46). Partly as a result of strong foreign protests notably from Japan and the U.K., there are moves favoring a "water's edge" form of domestic consolidation which limits the permissible scope of a unitary business to the domestic operations of affiliates incorporated in the U.S..

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Harmonization versus Local Identity

Given the global nature of the modern corporate economy and the diversity of disclosure and accounting standards, calls for voluntary or mandated harmonization come as no surprise. Simplification and comparability of disclosures across jurisdictions are the prime motives for harmonization, here defined as the process of reducing differences of disclosure practices between regions or jurisdictions. Harmonization has become compelling as an integral part of economic integration of jurisdictions and the desire to protect the rights of corporate constituents after integration.

Inasmuch as this 'leveling of the playing field' means stricter disclosure requirements in some regions or a regulatory shift to higher governmental levels (and thereby political and legal clout), it is opposed by business proponents, as witnessed in the debates surrounding the disclosure related Directives of the European Community. Business lobbyists have learned to use the politically effective argument that any tightening of disclosure requirements reduces a jurisdiction's competitiveness by increasing the cost of 'doing business' and the information available to competitors in other, less regulated jurisdictions. Other opponents of harmonization stress the uniqueness of economic, political, social and cultural environments arguing that imported standards do not fit a country's informational needs. Finally, stakeholders in disclosure friendly environments may feel informationally privileged and have no interest in harmonization.

Arguments for more uniform and explicit corporate accountability and informational safeguards can largely be traced to increased organizational and capital mobility. The European Community drafted its fourth directive (on accounting harmonization) in view of avoiding a European version of the "Delaware Phenomenon", i.e. "legal havens where systematic 'laisser faire' could be used to secure economic advantage" (Coleman 1984, p.5). Most supranational bodies have issued their guidelines in order to protect the interests of corporate constituents in host countries. However, national regulatory safeguards may be instituted on behalf of either home- or host-country constituents. A plant-closing notification requirement designed to stem the exodus of industries is a home-country regulation, while a special disclosure requirement for foreign owned plants represents a host-country mandate. Disclosure of information necessary to implement unitary taxation schemes could fall into either category, since both the home- and host country may have an interest in an unambiguous (or a more favorable) numerical basis for corporate income tax calculations.

As the United States, a traditional home country, is increasingly also becoming a host country for MNEs, calls for more stringent and uniform disclosure rules are more sympathetically received than they were when the U.S. opposed UN disclosure guidelines and the EC's Vredeling proposal (Samuels & Piper 1985). Even the chairman of the (U.S.) Financial Accounting Standards Board (FASB) acknowledged that the Board's attitude toward international accounting standards has changed from 'benign neglect', 'uninterested,' 'uncooperative' and 'less than enthusiastic'" to endorsing further internationalization (JA 1988). The more recent calls for instituting tougher reporting requirements for foreign investors to the U.S. would corroborate this change.

Finally, whose standards are to be adopted by whom and to what extent? The U.S. and U.K. have been standard- setting leaders in financial accounting while other European countries are at the forefront of social disclosures. In the field of financial accounting, there have been additional "zones of influence" such as the Franco - Spanish Portuguese zone; German - Dutch zone; and the East European area now looking for new international guidance. Some countries with well developed accounting and disclosure standards are willing to adjust them, for example, in recognition of the 4th and 7th EC Directives; a fitting example is the case of the German consolidation rules which had to be adjusted from domestic to world-wide consolidation. Finally, there are Third World countries which are building entirely new disclosure systems and are learning from the experience of countries other than or in addition to their former colonial masters (Samuels & Piper 1985). Factors facilitating the spread of accounting standards include the colonial traditions of training accountants; the influence of local subsidiaries of multinational corporations and of large American and British accounting firms (supported by the World Bank's and other international financial institutions' use of these firms for project audits); the spread of English as a second language; foreign aid; and the availability of scholarships for, and popularity of, a business education at British or American universities (Belkaoui 1988).

While one would expect that international accounting firms work towards greater uniformity of accounting standards, it would also be plausible that the existing complexity favors those large firms whose decentralized expertise is invaluable to multinational corporations. Harmonization, on the other hand, would make it easier for the mid-sized, second-tier auditing firms to survive. It would seem that the industry which, through mergers, was recently whittled down from the "Big Eight" to the "Giant Five", does not anticipate a major sim~lification of international accounting standards any time soon. [Footnote]

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Toward Empirical Disclosure Research

Last, not least, we come to the litmus test of respectable geographic inquiry: Is there any hope for empirical tests of meaningful hypotheses? Given the pivotal role of the large corporate organization in the modern economy, we need to know more about the nature, process, effects and limitations of information sharing. Two types of research are suggested. First, there are questions related to the conditions under which corporations disclose different kinds of information voluntarily. How do managers respond to external pressures for more or less disclosure by unions, governments, or the media? Waymire's (1985) finding that management's willingness to disclose earning forecasts decreases with earnings volatility suggests that managers are aware of the benefits and costs of publicizing more or less accurate forecasts.

Secondly, economic geographers have an interest in information disclosure as the explanatory variable: How do different disclosures satisfy the information needs and impact the behaviors of constituents? Two groups of studies have already addressed such questions: (a) research on the impact of earnings forecasts and other financial and non-financial information on investment decisions; changes in stock prices are usually taken as evidence for investor responsiveness ( Hoskin et al. 1986; Waymire 1985). (b) Studies tracing relationships between corporate disclosures and benefits derived by employees or other social or environmental stakeholders through early warnings in cases of plant closure, health hazards or other important risks and events ( Ingram & Frazier 1983; Freedman & Jaggi 1986; Ullman 1985; Viscusi et al. 1986). Whi]e these studies are highly suggestive, few consider geographic dimensions explicitly (See schema in Table 5).

Table 5. RELATIONSHIPS BETWEEN DISCLOSURE AND PERFORMANCE



Disclosure Economic/Business Social/Environmental Performance Performance (except disclosure performance)
Economic/ Financial (a) Impact of Influence of disclosure Disclosure disclosure on on stakeholders' stock prices expectations of environmental and (b) Impact of good social strategies performance on and performance disclosure propensities
Social/ Environmental Social disclosures may Disclosure designed Disclosure contain information to prevent greater useful for investment demands for social decisions; (e.g. stock or environmental prices react to performance; Disclosure disclosure of reflecting pride in pollution expenses firm's social/environm. performance

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Conclusions

The paper addressed a number of issues arising from increased size, mobility, volatility, and globalization of corporate organization and the related exacerbation of difficulties in accessing corporate information. In pursuit of these questions, the paper explored disclosure strategies and behaviors of multinational firms as well as selected disclosure mandates and guidelines. While many relevant issues have been empirically researched in the context of financial accounting, this paper also referred to the need for research into regionalized forms of social and environmental disclosures. Presently, concepts of segmentation and consolidation are rather narrowly defined by most countries' accounting standards. This frequently means that for multinational firms, operational segments are identified by regions as large as "Australasia". A review of annual reports of twelve large corporations from five countries and belonging to five industries confirmed earlier findings that geographically segmented disclosures do not do justice to the scope and international operations of the individual company due to extreme aggregation and lack of standardization. The need for more geographic detail and standardization has not yet been addressed by various international efforts to "harmonize" accounting rules.

The paper has cited other research on the information content of corporate announcements and reports. Most of such studies are capital-market oriented and employ financial performance measures as indicators for information content of disclosures. As such they are suggestive for a wider range of research questions involving information needs of stakeholders other than investors in different parts of world and at different geographic scales.

Notes:
1) The terms segmentation (disaggregated disclosure) and consolidation (aggregated disclosure) are here used to refer broadly to temporal periods, spatial incidence (locations and regions) as well as industrial and organizational (stakeholder) categories. Following the accounting literature, the terms segmentation and consolidation are also used more narrowly to refer to financial reporting requirements.

2) The new "Giant Five" firms would be (with 1988 combined worldwide revenues $ billion):


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