Chapter 17
Political Risk
Assessment
and
Management
Political Risk Assessment and
Management: Learning Objectives
•
•
•
•
Define and classify foreign political risks
Analyze firm-specific risks
Examine country-specific risks
Identify global-specific risks
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Defining Political Risk
• In order for an MNE to identify, measure and
manage its political risks, it needs to define and
classify these risks
– Firm-specific risks
– Country-specific risks
– Global-specific risks
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Defining Political Risks
• Firm-specific are those risks that affect the MNE at
the project or corporate level (governance risk due to
the goal conflict between an MNE and its host
government being the main political firm-specific
political risk in chapter; business risk and FX risk are
also in this category)
• Country-specific are those risks that also affect the
MNE at the project or corporate level but originate at
the country level (e.g. transfer risk, war risk, nepotism
& corruption)
• Global-specific are those risks that affect the MNE at
the project or corporate level but originate at the global
level (e.g. terrorism, anti-globalization, poverty)
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Classification of Political Risks
Firm-Specific
Risks
Country-Specific
Risks
• Governance risks
Global-Specific
Risks
• Terrorism & War
• Anti-globalization
Cultural and
Institutional Risk
Transfer Risk
movement
• Environmental
concerns
• Poverty
• Blocked funds
•
•
•
•
•
•
Ownership structure
Human resource norms
• Cyberattacks
Religious heritage
Nepotism & corruption
Intellectual property rights
Protectionism
Assessing Political Risk
• How can multinational firms anticipate government
regulations that, from the firm’s perspective, are
discriminatory or wealth depriving?
– 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 firmspecific activities are likely to conflict with host-country
goals as evidenced by existing regulations
– The most difficult task is to anticipate changes in hostcountry goal priorities
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Assessing Political Risk
• Predicting Firm-Specific Risk (Micro-Risk)
– The need for firm-specific analyses of political
risk has led to a demand for “tailor-made’
studies undertaken in-house by professional
political risk analysts
– In-house political risk analysts relate the macro
risk attributes of specific countries to the
particular characteristics and vulnerabilities of
their client firms
– Certainly, even the best possible analysis will
not reflect unforseen changes in the political or
economic situation
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Assessing Political Risk
• Predicting Country-Specific Risk (Macro-Risk)
– Macro political risk analysis is still an emerging
field of study
– These 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
– It is important to remember, especially in the
analysis of political trends, that the past will
certainly not be an accurate predictor of the
future
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Assessing Political Risk
• Predicting Global-Specific Risk
– Predicting this type of risk is even more difficult than the
other two types of political risk
– The attacks of September 11th, 2001 are an important
example of theses difficulties
– However, the military buildup in Afghanistan was not as
difficult to predict
– As we now live in a world with an expectation of future
terrorist attacks, we may begin to see country-specific
terrorism or other risk indices being developed
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Firm-Specific Risks
• Governance Risk
– This is the ability to exercise effective control
over and MNE’s operations within a country’s
legal and political environment
– For an MNE, however, governance is a subject
similar in structure to consolidated profitability –
it must be addressed for the individual business
unit and subsidiary as well as for the MNE as a
whole
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Firm-Specific Risks
• Negotiating investment agreements
– An investment agreement spells out the rights
and responsibilities of both the foreign firm and
the host government
– The presence of MNEs is as often sought by
development-seeking host governments as a
particular foreign location sought by an MNE
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Firm-Specific Risks
• An investment agreement should spell out policies on
financial and managerial issues; including the
following;
– Basis on which fund flows such as dividends, royalty
fees and loan repayments may be remitted
– Basis for setting transfer prices
– The right to export to third-country markets
– Obligations to build, or fund social and economic
overhead projects such as schools and hospitals
– Methods of taxation, including rate, type and means by
which rate is determined
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Firm-Specific Risks
– Access to host country capital markets
– Permission for 100% foreign ownership versus required
local partner
– Price controls, if any, applicable to sales in host country’s
markets
– Requirements for local sourcing versus importation of
materials
– Permission to use expatriate managerial and technical
personnel
– Provision for arbitration of disputes
– Provisions for planned divestment, indicating how the
going concern will be valued (build-to-own or build-totransfer)
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Firm-Specific Risks
• Investment insurance and guarantees:
OPIC
– MNEs can sometimes transfer political risk
through an investment insurance agency
– The US investment insurance and guarantee
program is managed by the Overseas Private
Investment Corporation (OPIC)
– It’s stated purpose is to mobilize and facilitate
US private capital and skills in the economic
development of less developed countries
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Firm-Specific Risks
• Investment insurance and guarantees: OPIC
– OPIC offers coverage for four separate types of risk
• Inconvertibility - risk that the investor will not be able to
convert remittances into dollars
• Expropriation – risk that the host government will seize the
assets of the US investor without restitution payments
• War, revolution & insurrection – covers damages to
physical property of foreign subsidiary
• Business income – coverage provides compensation for
loss of income due to events from political violence that
directly affect the company & its assets
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Operating Strategies
After the FDI Decision
• Although FDI creates obligations on the part of the
foreign subsidiary and host government, conditions
change and the MNE must be able to adapt
• There are several strategies that an MNE can
undertake to anticipate changing conditions or host
government’s future actions and negotiate these terms
– Local sourcing – firms may be required to purchase
raw materials from local producers
– Facility location – facilities may be located to minimize
risk
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Operating Strategies
After the FDI Decision
– Control of transportation – most important for oil and
pipeline companies
– Control of technology – control of key patents and
intellectual property
– Control of markets – common practice in order to
enhance a firm’s bargaining position
– Brand name & trademark control – gives MNE ability
to operate under a world brand name
– Thin equity base – foreign subsidiaries can be financed
with a thin equity base and large proportion of local debt
– Multiple-source borrowing – firm can borrow from
various banks and countries
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Country-Specific Risks
• These risks affect all firms, both domestic and
foreign operating within the host country
• Most typical risks are
– Transfer risk
– Cultural differences
– Host country protectionism
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Country-Specific Risks
• Transfer risk are the limitations on the MNE’s
ability to transfer funds into and out of a host
country without restrictions
• MNEs can react to potential transfer risk at three
stages
– Prior to making the investment, a firm can analyze the
effect of blocked funds
– 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 to avoid deterioration in real value
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Management Strategies for
Country-Specific Risks
Cultural and
Institutional Risk
Transfer Risk
Blocked Funds
• Preinvestment strategy to
anticipate blocked funds
• Fronting loans
• Creating unrelated exports
• Obtaining special
dispensation
• Forced reinvestment
Ownership Structure
Human Resource Norms
• Joint venture
• Local management &
staffing
Religious Heritage
Intellectual Property
• Understand and respect host • Legal action in host
country courts
country religious heritage
• Support worldwide treaty
to protect intellectual
Nepotism and Corruption property rights
• 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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Country-Specific Risks: Transfer Risk
• An MNE has at least six strategies for
transferring funds under restrictions
– Providing alternative conduits for repatriating
funds
– Transfer pricing goods & services between
subsidiaries
– Leading and lagging payments
– Using fronting loans
– Creating unrelated exports
– Obtaining special dispensation
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Country-Specific Risks: Transfer Risk
• Fronting loans
– A fronting loan is a parent-to-subsidiary loan
channeled through a financial intermediary
– The lending parent deposits the funds in a bank,
let’s say in London
– That bank in turn “loans” this amount to the
borrowing subsidiary
– In essence, the bank “fronts” for the parent
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Country-Specific Risks: Transfer Risk
• Creating unrelated exports
– Because main reason for stringent exchange controls is
a host country’s ability or inability to earn hard currency,
anything an MNE can do to generate export sales helps
the host country
– Some exports can be created from present productive
capacity or through production of unrelated products and
services for export
• Special dispensation
– If the firm is in an important industry for the development
of the host country, it may bargain for a special
dispensation to repatriate some funds
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Country-Specific Risks: Cultural
and Institutional
• 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
such as:
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–
–
–
–
–
Differences in allowable ownership structure
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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Global-Specific Risks
• Global-specific risks faced by MNEs have come to the
forefront in recent years:
–
–
–
–
–
–
–
–
Terrorism and War
Crisis Planning
Cross-Border Supply Chain Integration
Supply Chain Interruptions (Inventory Management,
Sourcing, Transportation)
Antiglobalization Movement
Environmental Concerns
Poverty
Cyberattacks
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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
• Support government
occupational safety standards
anti-cyber attack efforts
MNE movement towards multiple primary objectives:
Profitability, Sustainable Development, Corporate Social Responsibility
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Mini-Case: Globalization and
Starbucks Coffee
• Starbucks found itself an early target of the
anti-globalist movement
• Like McDonald’s, Starbucks found that its
uniquely defined brand and experience did not
have to conform to local cultural norms, but
could exist alongside traditional practices
• Unlike McDonald’s, Starbucks was the
purveyor of a commodity (coffee), which was
priced and sold on global markets
• Coffee is sourced from hundreds thousands of
small growers in Central and South America
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Mini-Case: Globalization and
Starbucks Coffee
• Coffee was traditionally bought and sold using market
pricing, buying from wholesalers at a global market
price
• Starbucks, however, preferred to purchase using
outright pricing, in which the price was negotiated
directly with small and medium-sized farmers (cutting
out wholesalers)
• In principle, a greater proportion of the price would go
to the growers
• Additionally, Starbucks was moving to set up longerterm purchase contracts instead of buying only in the
cash market
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Mini-Case: Globalization and
Starbucks Coffee
• The single biggest problem for Starbucks was the price
of coffee itself
• As can be seen in the next exhibit, the global price of
Arabica Bean Coffee has been extremely volatile
• In recent years, the price had plummeted, as more and
more production created and excess supply
• By 2001, Starbucks had implemented a multitude of
programs to pursue its program for corporate social
responsibility (CRS) and pursue sustainable economic
development for people in its supply chain
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Arabica Bean Coffee Prices,
1981-2001
US cents/pound
160
140
120
100
80
60
40
20
0
1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Source: International Coffee Organization (ICO), www.ico.org.
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Mini-Case: Globalization and
Starbucks Coffee
• Much of the growing pressure on all
multinational companies for sustainable
development and social responsibility arose
directly from consumer segments
• The following exhibit illustrates Starbucks
efforts in its program called Commitment to
Origins
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Starbucks’ CSR Programs Focusing on
Coffee Growers
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
Fair Trade Certified 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)
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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Mini-Case: Globalization and
Starbucks Coffee
• Although very aggressive in the eyes of many,
the anti-globalization movement continued to
focus much of its efforts on Starbucks
• Although Starbucks had actively pursued a
number of corporate social responsibility
initiatives, it was accused of polishing its image
more than truly working to improve the lives of
those its existence depended upon, the coffee
growers
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Summary of Learning Objectives
• Political risks can be defined by classifying them on
three levels, namely firm-specific, country-specific, or
global-specific
• Firm-specific risks, also known as micro risks, are
those that affect the MNE at the project or corporate
level
• Country-specific risks, also known as macro risks, are
those risks that also affect the MNE at the project or
corporate level but originate at the country level
• Global-specific risks are those risks that affect the MNE
at the project or corporate level but originate at the
global level
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Summary of Learning Objectives
• The main firm-specific risk is governance risk, which is
the ability to exercise control over the MNE as a whole,
globally, and within a specific country’s legal and
political environment on the individual subsidiary level
• The most important type of governance risk arises from
a goal conflict between bona fide objectives of
governments and private firms
• The main tools used to manage goal conflict are to
negotiate and investment agreement, purchase
investment insurance and guarantees and to modify
operating strategies in production, logistics, marketing,
finance, organization and personnel
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Summary of Learning Objectives
• The main country-specific risks are transfer
risk, known as blocked funds, and certain
cultural and institutional risks
• Blocked funds can be managed by at least five
different strategies
• Cultural and institutional risks emanate from
host country policies with respect to ownership
structure, human resource norms, religious
heritage, nepotism and corruption, intellectual
property rights, and protectionism
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Summary of Learning Objectives
• Managing cultural and institutional risks requires the
MNE to understand the differences, take legal actions
in host country courts, support worldwide treaties to
protect intellectual property rights, and support
government efforts to create regional markets
• The main global-specific risks MNEs are currently
caused by terrorism and war, the anti-globalization
movement, environmental concerns, poverty and
cyberattacks
• MNEs need to adopt a crisis plan to protect itself, its
employees and property in the face of such threats
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Exhibit 17.1 Classification of Political
Risks
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Exhibit 17.2 Country Risk Ratings for
Selected Countries
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Exhibit 17.3 Management Strategies
for Country-Specific Risks
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Exhibit 17.4
Transparency
International’s
Corruption
Perception
Index, 2002
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Exhibit 17.5 Types of Non-Tariff Barriers
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Exhibit 17.6 Management Strategies
for Global-Specific Risks
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Exhibit 1 Arabica Bean Coffee
Prices, 1981–2001
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Exhibit 2 Starbucks’ CSR Programs
Focusing on Coffee Growers
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Exhibit 3 Cyberattack: The Starbucks
Campaign
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