The IMF's Statistical Systems in Context of Revision of the United Nations' A System of National Accounts
Chapter

12 Classification of Corporate Enterprises

Author(s):
Vicente Galbis
Published Date:
September 1991
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Author(s)
D. Keith McAlister

The Expert Group on Production Accounts and Input-Output Tables suggested that the revised version of the United Nations' A System of National Accounts (SNA) include a recommendation that the accounts for the corporate enterprise sector be prepared separately for private and government-owned as well as for resident- and foreign-owned enterprises. (In this connection it is presumed that the terms resident-owned and foreign-owned refer to enterprises that are, more accurately, resident-controlled or foreign-controlled in that an enterprise can have both resident and foreign ownership of its voting equity; thus, although such an enterprise cannot be said to be wholly resident-owned or foreign-owned, its control can be assigned.) The Group further suggested that a paper describing the criteria used for distinguishing between resident-owned and foreign-owned enterprises, particularly in relation to the definition of direct investment, be prepared.

The desire to distinguish between resident-owned and foreign-owned enterprises stems from the perception that there may be discernible quantitative differences in such attributes as value added, profitability, level of investment, and employment, and that statistics that differentiate between foreign and domestic ownership of enterprises would be useful for analytical purposes. This paper examines the notion of foreign ownership with reference to the concept of direct investment as currently formulated in the fourth edition of the IMF's Balance of Payments Manual (BPM) and further elaborated in the “Benchmark Definition” of direct investment of the Organization for Economic Cooperation and Development (OECD).1

I. Definition of Direct Investment

In the BPM, “direct investment” refers to investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor's purpose being to have an effective voice in the management of the enterprise. The foreign entity or group of associated entities that makes the investment is called the direct investor. The unincorporated or incorporated enterprise—a branch or subsidiary, respectively—in which direct investment is made is referred to as a direct-investment enterprise.

With a view to making the definition of a direct-investment enterprise more operational, the OECD “Benchmark Definition” (paragraph 13, page 7) suggests that

… A direct-investment enterprise be defined as an incorporated or unincorporated enterprise in which a single foreign investor … either:

  • (a) controls 10 percent or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise, unless it can be established that this does not allow the investor an effective voice in the management of the enterprise; or

  • (b) controls less than 10 percent (or none) of the ordinary shares or voting power of the enterprise but has an effective voice in the management of the enterprise.

The single foreign (direct) investor may be an individual, an incorporated or unincorporated public or private enterprise, a government, a group of related individuals, or a group of related incorporated or unincorporated enterprises. An effective voice in the management of an enterprise implies only that the direct investor is able to influence or participate in the management of the enterprise and does not imply control. In some countries, studies are produced to compare foreign- and resident-controlled enterprises, in which control is defined more narrowly than direct investment. For example, the threshold for defining control may be higher, and the enterprise may be considered to be domestically controlled if there is a larger domestic than foreign investor participating in the enterprise. In practice, however, most direct-investment enterprises would be considered foreign controlled.

The OECD “Benchmark Definition” (paragraph 21) subdivides direct-investment enterprises into branches, subsidiaries, and associate companies.

A branch is an unincorporated (“quasi-corporate” in current SNA terminology) enterprise in the host country that

  • Is a permanent establishment or office of a foreign direct investor or

  • Is an unincorporated partnership or joint venture between a foreign direct investor and third parties or

  • Is land or structures (except those owned by foreign government entities) in the host country directly owned by a foreign resident or

  • Is mobile equipment (such as ships, aircraft, and gas and oil drilling rigs) that operates within an economy for at least one year (considered to be direct investment in a notional enterprise in the host country).

A resident company X is a subsidiary of a foreign enterprise N if the latter

  • Controls more than half of the shareholders' or members' voting power in X or

  • Is a shareholder in or member of X and has the right to appoint or remove a majority of the members of X's administrative, management, or supervisory body or

  • Has a subsidiary company Y of which X is a subsidiary.

A resident company K is an associate of the foreign enterprise N if

  • N and its subsidiaries control between 10 percent and 50 percent of the shareholders' voting power in K and this allows N to have an effective voice in K's management or

  • N and its subsidiaries control less than 10 percent of K but have an effective voice in K's management.

Because the Expert Group on External Sector Transactions suggested that the OECD “Benchmark Definition” be used in a revised BPM, the relationship between foreign ownership and direct investment, which is discussed in the following section, is examined with reference to that definition.

II. Foreign Ownership and Direct Investment

In terms of the categories of direct-investment enterprises described in the preceding section, branches and subsidiary companies of foreign enterprises would be viewed as either wholly or majority foreign-owned. For associate companies, several situations are possible. First, the direct investor could hold, say, 10 percent of the voting stock, while nonresident portfolio investors who are widely dispersed and unrelated could collectively hold, say, 41 percent. Thus, in the aggregate, foreign ownership comprising the direct investors' share and the portfolio investors' shares could characterize the direct-investment enterprise as being majority foreign-owned. Second, the foreign direct investor could hold, say, 49 percent of the voting stock while residents hold the remainder. In this case, a direct-investment enterprise as defined in the preceding section would not necessarily be a foreign-owned enterprise. In exceptional cases, the foreign portfolio investors may account for more than 50 percent of the voting stock of an enterprise in which there is no direct investor; such an enterprise may be deemed to be foreign-owned although not a direct-investment enterprise.

Should foreign ownership of a resident enterprise reflect mainly foreign ownership of capital invested in the enterprise, or should it be interpreted as ability to affect its management? Because the purpose of the classification is to categorize the statistics of enterprises, presumably to see if discernible differences exist based on ownership, it would be analytically more appropriate to identify those enterprises whose management is characterized by foreign influence. Foreign rather than local management is likely to contribute to differences in the economic performance of direct-investment enterprises, on the one hand, and of all other resident enterprises, on the other. This effect is particularly likely in large corporations that engage in multinational operations because a small, organized group of stockholders may well have an influence in management that is proportionately greater than its share in the equity capital. Such large corporations also often contribute technical know-how that can make for differences in productivity between a direct-investment enterprise and other resident enterprises.

III. Availability of Data

Currently in the balance of payments accounts, direct investment and portfolio investment are separate functional categories, although some of the direct-investment and portfolio investment flows could conceivably be directed to the same direct-investment enterprise. By extension to the international investment position accounts, data on balance sheets distinguish between stocks of foreign direct investment and foreign portfolio investment. In several countries that compile data on the stock of direct investment, a further disaggregation is provided in the form of an abbreviated industry breakdown, often in terms of the International Standard Industrial Classification (ISIC) at the one- or two-digit level.2 Data based on direct-investment enterprises rather than strictly on majority foreign ownership by direct investors are likely to be available, especially in countries compiling extensive data on direct-investment flows and stocks.

In light of the foregoing considerations, and in view of the heightened interest in the transactions taking place between affiliated enterprises, it is suggested that, where applicable, data on enterprises distinguish between direct-investment enterprises and other resident enterprises. Because direct-investment enterprises encompass the activities of their subsidiaries, these criteria would also apply to the domestic subsidiaries of direct-investment enterprises. For example, if a chain of subsidiaries of a direct-investment enterprise is operating in a different industry and if over 50 percent of the voting stock of each subsidiary is owned by a parent enterprise, all these enterprises should be considered foreign-owned for the purpose of the enterprise classification. The domestic parent—the direct-investment enterprise—is clearly foreign-owned according to the preceding definition of foreign ownership. These relations are illustrated in Figure 1.

Figure 1.Domestic Subsidiaries of a Foreign-Owned Direct-Investment Enterprise

The application of the criteria for foreign ownership to the disparate units of an enterprise group and the production of separate statistics for each unit rather than a consolidated total for the enterprise group will ensure that the industry statistics being classified are as meaningful as possible.

In sum, the main question is whether experts agree that resident corporate enterprises should be classified as direct-investment enterprises and nondirect-investment enterprises rather than as foreign-owned and domestically owned enterprises (as determined by majority ownership of equity).

OECD, “Detailed Benchmark Definition of Foreign Direct Investment,” General Distribution, BOP.B2 (Paris, February 1983).

United Nations, International Standard Industrial Classification of All Economic Activities, Statistical Papers, Series M, No. 4, Rev. 3 (New York, 1986).

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