1. Political Risk Assessment and Management
Chapter 16
Political Risk Assessment and Management

2. Defining Political Risk
In order for an MNE to identify, measure, and manage its political risks, it must define and classify these risks.
This text classifies these risks as:
Firm-specific
Country-specific
Global-specific
This method of risk classification differs from the traditional method that classifies risks according to the disciplines of economics, finance, political science, sociology and law.
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3. Exhibit 16.1 Classification of Political Risks
Firm-Specific
Risks
Country-Specific
Risks
Global-Specific
Risks
• Business risks
• Terrorism & War
• Foreign-exchange
risks
• Anti-globalization
movement
Transfer Risk
Cultural and
Institutional Risk
• Governance risks
• Environmental
concerns
• Poverty
• Blocked funds
• Ownership structure
• Cyberattacks
• Human resource norms
• Religious heritage
• Nepotism & corruption
• Intellectual property rights
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• Protectionism

4. Assessing Political Risk
At the macro level, firms attempt to assess a host country’s political stability and attitude toward foreign investors.
At the micro level, firms analyze whether their firm-specific activities are likely to conflict with host-country goals as evidenced by existing regulations.
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5. Assessing Political Risk
Predicting firm-specific risk (micro risk):
Assessing the political stability of a country is only a first step
The real objective is to anticipate the effect of political changes on activities of a specific firm
Clearly, different foreign firms operating within the same country may have very different degrees of vulnerability to changes in host-country policy or regulations
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6. Assessing Political Risk
Predicting country-specific risk (macro risk):
Political risk studies usually include an analysis of the historical stability of the country in question, evidence of present turmoil or dissatisfaction, indications of economic stability, and trends in cultural and religious activities
Analysis of trends in these metrics leads many to speculate that the future will resemble the past, which is often not the case
Despite this difficulty, the MNE must conduct adequate analysis in preparation for the unknown
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7. Assessing Political Risk
Predicting global-specific risk:
Global-specific risk is clearly quite difficult to predict (i.e. September 11th)
There are many groups interested in disrupting MNEs operations for the cause of religion, anti-globalization, environmental protection, and even anarchy
We can expect to see a number of new indices, similar to country-specific indices, but devoted to ranking different types of terrorist threats, their locations, and potential targets
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8. Firm-Specific Risks
The firm-specific risks that confront MNEs include:
Business risk
Foreign exchange risk
Governance risks
Governance risk is the ability to exercise effective control over an MNE’s operations within a country’s legal and political environment
For an MNE, it must be addressed for the individual business unit as well as for the MNE as a whole
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9. Firm-Specific Risks Corporate governance principles include:
Accountability (transparent ownership, appropriate board size, defined board accountability, and ownership neutrality)
Disclosure and transparency (broad, timely and accurate disclosure, use of proper accounting standards)
Independence (dispersed ownership, independent audits and oversight, independent directors)
Shareholder equity (one share, one vote)
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10. Firm-Specific Risks Negotiating investment agreements:
An investment agreement spells out specific rights and responsibilities of both the foreign firm and host government
The presence of MNEs is as often sought by development-seeking host governments as a particular foreign location is sought by an MNE
An investment agreement should spell out policies on many areas including (among others):
The basis of fund flows (fees, royalties, dividends)
The basis for setting transfer prices
The right to export to third-country markets
Methods of taxation
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11. Firm-Specific Risks Investment insurance and guarantees: OPIC
MNEs can sometimes transfer political risk to a home-country public agency through an investment insurance and guarantee program
The US investment insurance and guarantee program is managed by the government-owned Overseas Private Investment Corporation (OPIC)
OPIC offers insurance for four separate types of political risk:
Inconvertibility
Expropriation
War, revolution, insurrection, and civil strife
Business income (resulting from political violence)
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12. Firm-Specific Risks Operating strategies after the FDI decision:
Although an investment agreement creates obligations on the part of both foreign investor and host government, conditions change and agreements are often revised in the light of such changes
Most MNEs, in their own self-interest, follow a policy of adapting to changing host-country priorities whenever possible
The essence of such adaptation is anticipating host-country priorities and making the activities of the firm of continued value to the host country
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13. Firm-Specific Risks Host countries may look for control of:
Local sourcing of raw materials and components
Facility location
Transportation
Technology
Markets
Brand names and trademarks
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14. Country-Specific Risks: Transfer Risk
Transfer risk is defined as limitations on the MNE’s ability to transfer funds into and out of a host country without restrictions.
When a government runs short of foreign exchange and cannot obtain additional funds through borrowing or attracting new foreign investment, it usually limits transfers of foreign exchange out of the country, a restriction known as blocked funds.
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15. Exhibit 16.4 Management Strategies for Country-Specific Risks
Transfer Risk
Cultural and
Institutional Risk
Blocked Funds
Ownership Structure
Human Resource Norms
• Preinvestment strategy to
anticipate blocked funds
• Joint venture
• Local management & staffing
• Fronting loans
Religious Heritage
Intellectual Property
• Creating unrelated exports
• Understand and respect host
country religious heritage
• Legal action in host
country courts
• Obtaining special dispensation
• Forced reinvestment
• Support worldwide treaty
to protect intellectual
property rights
Nepotism and Corruption
• Disclose bribery policy to both
employees and clients
Protectionism
• Retain a local legal advisor
• Support government
actions to create
regional markets
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16. Country-Specific Risks: Transfer Risk
MNEs can react to the potential for blocked funds at three stages:
Prior to making an investment, a firm can analyze the effect of blocked funds on return on investment, the desired local financial structure etc.
During operations a firm can attempt to move funds through a variety of repositioning techniques
Funds that cannot be moved must be reinvested in the local country in a manner that avoids deterioration in their real value because of inflation or exchange depreciation
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17. Country-Specific Risks: Cultural and Institutional Risks
When investing in some of the emerging markets, MNEs that are resident in the most industrialized countries face serious risks because of cultural and institutional differences:
Differences in allowable ownership structures
Differences in human resource norms
Differences in religious heritage
Nepotism and corruption in the host country
Protection of intellectual property rights
Protectionism
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18. Country-Specific Risks: Cultural and Institutional Risks
Ownership structure:
Many countries have required that MNEs share ownership of their foreign subsidiaries with local firms or citizens
This requirement has been eased in most countries in recent years
Human resource norms:
MNEs are often required by host countries to employ a certain proportion of host country citizens rather than staffing mainly with foreign expatriates
It is often very difficult to fire local employees due to host country labor laws and union contracts
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19. Country-Specific Risks: Cultural and Institutional Risks
Religious heritage:
Despite religious differences, MNEs have operated successfully in emerging markets, especially in extractive and natural resource industries such as oil, natural gas, minerals and forest products
Nepotism and corruption:
There is clearly endemic nepotism and corruption in many important foreign investment locations
Bribery is not limited to emerging markets, as it is also a problem in industrialized nations such as the US and Japan
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20. Country-Specific Risks: Cultural and Institutional Risks
Intellectual property rights:
Intellectual property rights grant the exclusive use of patented technology and copyrighted creative materials
Courts in some countries have historically not done a fair job of protecting these rights
Protectionism:
Protectionism is defined as the attempt by a national government to protect certain of its designated industries from foreign competition
Industries that are usually protected are defense, agriculture, and infant (emerging) industries
Protectionism occurs through the use of tariff and non-tariff barriers
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21. Global-Specific Risks
Global-specific risks faced by MNEs have come to the forefront in recent years:
Terrorism and war
Poverty
Anti-globalization
Cyber attacks
Environmental concerns
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22. MNE movement towards multiple primary objectives:
Exhibit Management Strategies for Global-Specific Risks
Terrorism & War
Anti-Globalization
Environmental Concerns
• Support government
efforts to flight terrorism
and war
• Support government
efforts to reduce trade
barriers
• Show sensitivity to
environmental concerns
• Crisis planning
• Recognize that MNEs
are the targets
• Support government efforts
to maintain a level playing
field for pollution controls
Poverty
Cyber Attacks
• Provide stable, relatively
well-paying jobs
• No effective strategy
except internet security
efforts
• Establish the strictest of
occupational safety standards
• Support government
anti-cyber attack efforts
MNE movement towards multiple primary objectives:
Profitability, Sustainable Development, Corporate Social Responsibility
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23. Illustration of Global-Specific Risks: The Case of Starbucks
Starbucks found itself an early target of the anti-globalist movement.
The company appeared to be yet another American cultural imperialist.
As global prices for coffee plummeted in the late 1990’s, companies like Starbucks were criticized as being unwilling to help improve the economic conditions of the coffee growers themselves
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24. Exhibit 16.8 Arabica Bean Coffee Prices, 1981-2001
US cents/pound
Source: International Coffee Organization (ICO),
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25. Illustration of Global-Specific Risks: The Case of Starbucks
Much of the growing pressure on all multinational companies for sustainable development and social responsibility arose directly from consumer segments.
In response, the company introduced in 1998 coffee that was cultivated under the canopy of shade trees in host countries (a practice considered ecologically sound).
In addition, in 2000, the company introduced “Fair Trade” coffee in an effort to improve the living standards of coffee growers
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26. Starbucks’ coffee buyers work with coffee wholesalers and directly
with small farmers and farm cooperatives in procurement
Infrastructure, including
schools, clinics, and coffee
processing facilities
Supplemental funding for
farm credit programs to
support farm capital needs
Contributions to CARE,
the non-profit international
relief organization
Shade Grown Mexico Brand
Partnership formed in 1998, encourages
production of shade-grown coffee using
ecologically sound growing practices to
promote bio-diversity and to financially
support farms employing these practices
(with Conservation International, CI)
Fair Trade Certified Brand
Partnership in which Starbucks promises
consumers that the farmers who produced
the coffee beans were paid a guaranteed
minimum price that helps support a better life for farm families (with TransFair USA)
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