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...