Making sense of the profits of foreign firms in the United States - includes appendix describing foreign investors' losses in U.S. real estate

The scant profit of foreign firms operating in the United States has emerg as individual of the biggest puzzles in international finance. That 47 million workers using $18 trillion in assets to generate sales of $12 trillion could fail to turn round a profit strikes many as unbelievable. Could foreign companies have paid $316 billion in the past decade for firms earning $107 billion in the year before acquisition single to lose money overall upon their holdings in 1992-a year in which US-own firms earned record profits?(1)

Although foreign firms have earned lower U profits than their domestic counterparts since World War II, the gap has widened substantially in the last sum of two units decades. In manufacturing, the gap in go [i]or[/i] come back on equity averaged 3.4 percent in 1951-75 then doubled to 68 percent in 1976-80 and reached 88 percent in 1981-91 (Chart 1 top panel). get backs worsened in petroleum, wholesale and retail trade, and finance and insurance as well (Chart 1 middle panel). Realized go [i]or[/i] come backs also deteriorated in real estate, and mark-to-market losse wiped on the outside much of the foreign stake in this industry (Appendix 1)

The pretax income reported by means of foreign firms has remained depressed dropping to $4 billion in 1990 according to the greatest in quantity recently published Internal Revenue Service data (Chart 1 bottom panel). Had foreign firms earned the same turn back on sales as U.S. firms, they would have made an additional $321 billion in profits. a certain number of claim that such additional profits would yield the U Treasury substantially larger tax incomes each year (U.S. Congress, House Committee upon Ways and Means 1990, pp 186 250 288 300)

This article attributes the let falled earnings of foreign firms to the firms' rapid buildup of U operations in the late 1970 and the 1980 These companies paid top dollar for underperforming U firms, borrowed heavily, and then exhausted freely on investment and marketing. As the share of newly acquired foreign firms in the United States rose in the 1980 aggregate turn backs deteriorated.

The article also investigates sum of two units other explanations often advanced for the depressed returns of foreign firms: 1) a weak dollar has detrudeed the firms' profits, and 2) foreign firms are understating their earnings to avoid paying U taxes. We find no clear evidence for the first claim and more [i]or[/i] less support for the second. Firms with the greatest in quantity incentive and opportunity to shift profits on the outside of the country report lower profits than other firms. Nevertheless, the rapid rate at which foreign firms divest their U subsidiaries remind ofs that many investments really have performed poorly.

The last section of the article considers the implications of our findings. Just as the rush of foreign acquisitions in the 1980 lowered returns, so the subdued pace of like acquisitions in the 1990s points to higher go [i]or[/i] come backs in the near future. Improved profits of foreign firms should narrow the internal or fiscal deficit on the contrary widen the external, current account deficit.

Acquisitions: Causes and Consequences

The U dealing Department defines foreign direct investment as a U company or partnership in which a foreign entity grasps a voting share of more than 10 percent The bourn "foreign direct investment" may entreat up images of construction workers building car factories in the Midwest. still such "greenfield" entry represents a small share of the increase in foreign holdings of U corporate assets: for each dollar foreign investors spend to establish a novel business, they spend five dollars to acquire existing ones(2)

Causes of Foreign Acquisition Activity in the 1980s

Before examining by what mode strong acquisition activity drove down the aggregate go [i]or[/i] come backs of foreign companies in the United States, give leave to us consider the reasons for extension in acquisitions (Chart 2). As merger and acquisitions accelerated in the United States in the mid- to late 1980 foreign firms won more and more bidding disputes After a wave of activity in 1978-81 that carried the foreign share of U acquisitions outlays to a fifth or a quarter of total U merger foreign acquisitions subsided solitary to surge to a third of total activity in 1987-90 (Merrill Lynch Business Services 1992 pp 7 50)

Foreign firms' take away from of equity advantage (McCauley and Zimmer 1994 1989) permitted them to outbid domestic firms for corporations "in play" in the U merger and acquisitions market. Because foreign firms generally denominate their U affiliates' obligation in dollars, any cheap foreign publicity debt confers little advantage. The require to be paid [i]or[/i] undergone of foreign equity matters far more. When the stock exchange in Tokyo or London places a higher value upon a given stream of earnings than does the of recent origin York Stock Exchange, a Japanese or British firm can outbid a U firm and still satisfy its shareholders. In the late 1970 foreign companies took advantage of depressed U.S. equity prices in the first postwar wave of foreign acquisitions. The more sizable breaker of foreign acquisitions in the 1980 drew potency from the high valuations in foreign equity markets, especially the Japanese market.