Chapter 16
Political Risk
Assessment
and Management
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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Exhibit 16.1 Classification of Political Risks
Firm-Specific
Risks
Country-Specific
Risks
Global-Specific
Risks
• Business risks
• Terrorism & War
• Foreign-exchange
• Anti-globalization
risks
• Governance risks
Cultural and
Institutional Risk
Transfer Risk
movement
• Environmental
concerns
• Poverty
• Blocked funds
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•
•
•
•
•
•
Ownership structure
• Cyberattacks
Human resource norms
Religious heritage
Nepotism & corruption
Intellectual property rights
Protectionism
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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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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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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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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, antiglobalization, 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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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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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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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 developmentseeking 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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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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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 hostcountry priorities and making the activities of the
firm of continued value to the host country
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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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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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Exhibit 16.4 Management Strategies
for Country-Specific Risks
Cultural and
Institutional Risk
Transfer Risk
Blocked Funds
Ownership Structure
Human Resource Norms
• Preinvestment strategy to
anticipate blocked funds
• Fronting loans
• Joint venture
• Local management & staffing
• Creating unrelated exports
Religious Heritage
• Understand and respect host
country religious heritage
• Obtaining special dispensation
• Forced reinvestment
Nepotism and Corruption
• Disclose bribery policy to both
employees and clients
• Retain a local legal advisor
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Intellectual Property
• Legal action in host
country courts
• Support worldwide treaty
to protect intellectual
property rights
Protectionism
• Support government
actions to create
regional markets
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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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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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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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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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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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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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Exhibit 16.7 Management Strategies for GlobalSpecific 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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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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Exhibit 16.8 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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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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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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