In recent years, Argentina has made tremendous economic progress. Among other important points, it can boast of improvements in the productivity of both labor and capital. But for all these advances, a McKinsey study of 22 leading Argentine companies found that three-quarters of them are destroying value. A leading culprit: the high cost of capital for local companies.

The study sample, representing 70 percent of the country's stock market capitalization and including both local companies and subsidiaries of multinationals, focused on economic profit—the profitability that is generated by a company above its cost of capital. Although these companies collectively had operating profits of $15 billion, they had destroyed approximately $5 billion of their accumulated value, representing almost 20 percent of their invested capital during the five-year period from 1993 to 1998 (Exhibit 1, part 1). In other words, their returns failed to match what investors could have obtained elsewhere given a similar level of risk.

Argentina's economic situation resembles that of other Latin American states, but local companies destroyed three times more value on a percentage basis than did their Chilean counterparts during those years. Meanwhile, Brazil, which still has many state-owned companies, destroyed 46 percent of its invested capital. US companies, by contrast, generated value—about 7 percent of their invested capital (Exhibit 1, part 2).

The challenge Argentine companies face in generating returns above the cost of invested capital runs through the whole economy. The construction, energy generation, oil, steel, and telecommunications industries destroyed value amounting to at least 14 percent of their invested capital from 1993 to 1998. Banking, consumer goods, and gas distribution also had negative results, varying from 1 to 5 percent. The exception to this trend was the supermarket sector, which created value amounting to about 11 percent of its invested capital during this period. (Besides benefiting significantly from a surge in demand and geographic expansion, supermarkets extracted value from their vendors.) Local companies show returns on capital similar to those of the United States—returns clearly insufficient for a developing country, taking into account the economic growth of the years considered for this analysis—and the cost of capital is much higher.

Argentine companies face two main problems in their efforts to create economic profit: this high cost of capital (Exhibit 2) and the heavy investments of the 1990s. The high cost of capital stems from the country's elevated level of risk, real or perceived, and reflects external and internal problems, such as fiscal deficits and Argentina's relatively fragile institutions and legal system. As for the country's other main problem—namely, heavy investment—both privatization and deregulation led Argentine companies to sink a good deal of money into infrastructure, equipment, and other assets between 1993 and 1998. Many of these investments, though certainly required to help companies remain in business, didn't necessarily help to generate returns in the medium term. A great many major companies therefore show low returns on invested capital.

Other factors also contribute to the underperformance of Argentine companies. The most relevant are the absence of a value generation culture among both managers and shareholders in Argentina, of management (that is, governance) mechanisms and tools to support the creation and nurturing of such a culture, and of incentive systems that would encourage the creation of value by companies.