Increasingly, investor are understanding that projects can be derailed by little p political risk.., the death from 1,000 cuts.28
The managers of a global firm need to investigate the political risks to which they expose their company in certain countries and the implications of those risks for the economic success of the firm. Political risks are any governmental action or politically motivated event that could adversely affect the long-run profitability or value of a firm.29 The Middle East, as we have seen, has traditionally been an unstable area where political risk heavily influences business decisions.
In unstable areas, multinational corporations weigh the risks of nationalization or expropriation. Nationalization refers to the forced sale of the MNCs assets to local buyers, with some compensation to the firm, perhaps leaving a minority ownership with the MNC. Expropriation, very rare in the last decade, occurs when the local government seizes the foreign-owned assets of the MNC, providing inadequate compensation; in the case of no compensation, it is known as confiscation. In countries that have a proven history of stability and consistency, the political risk to a multinational corporation is relatively low. The risk of expropriation is highest in countries that experience continuous political upheaval, violence, and change. Events that affect all foreign firms doing business in a country or region are called macropolitical risk events. In the Middle East, Iraqs invasion of Kuwait in 1990 abruptly halted all international business with and within both those countries and caught businesses wholly unprepared. In China, the Tiananmen Square crackdown on student protestors in 1989 interrupted much foreign business in the Far East. After years of increasing international investment in China (the United States had reached the $3-billion mark in direct foreign investment at the time of the crackdown), many companies closed and withdrew their personnel. Concerned about the governments response to student unrest, these businesses were wary about the future.
The political uncertainty and unrest in the newly independent countries of Eastern Europe are a prime example of the risk-return trade-off that companies must assess. The attraction in Russia, for example, though it struggles in its transition to a market economy, is the considerable potential profits available to investors in the consumer goods sector which can accrue from the pent-up demand for goods for 150 million people who are beginning to realize some economic growth. The continuing uncertainty has also not deterred Japan from setting up bases in Eastern Europe to penetrate the European Community market.
In many regions, terrorism poses a severe and random political risk to company personnel and assets and can, obviously, interrupt the conduct of business. According to Micklous, terrorism is the use, or threat of use, of anxiety-inducing. . . violence for ideological or political purposes. The increasing incidence of terrorism, especially in Latin America, concerns MNCs. In particular, the kidnapping of business executives has become quite common. Those events that affect one industry or company or only a few companies are called micropolitical risk events. These types of events have become more common than macrorisk events. Such microaction is often called creeping expropriation, indicating a governments gradual and subtle action against foreign firms.35 This is when the death from a 1,000 cuts comes in-when you havent been expropriated, but it takes ten times longer to do anything.36 Such continuing problems with an investment present more difficulty for foreign firms, typically, than major events which are insurable by political-risk insurance agencies. The following list describes seven typical political risk events common today (and possible in the future).
1. Expropriation of corporate assets without prompt and adequate compensation
2. Forced sale of equity to host-country nationals, usually at or below depreciated book value
3. Discriminatory treatment against foreign firms in the application of regulations or laws
4. Barriers to repatriation of funds (profits or equity)
5. Loss of technology or other intellectual property (such as patents, trademarks, or trade names)
6. Interference in managerial decision making
7. Dishonesty by government officials, including cancelling or altering contractual agreements, extortion demands, and so forth
Political Risk Assessment
International companies must conduct some form of political risk assessment to manage their exposure to risk and to minimize financial losses. Typically, local managers in each country assess the potentially destabilizing issues and evaluate their future impact on the company, making suggestions for dealing with possible problems. Corporate advisers then establish guidelines for each local manager to follow in handling these problems. Dow Chemical has a program in which it uses line managers trained in political and economic analysis as well as executives in foreign subsidiaries to provide risk analyses of each country.
Risk assessment by multinational corporations usually takes two forms. One is through the use of experts or consultants familiar with the country or region under consideration. Such consultants, advisers, and committees usually monitor important trends that may portend political change, such as the development of opposition or destabilizing political parties. They then assess the likelihood of political change and develop several plausible scenarios to describe alternative political conditions in the future.
A second and increasingly common means of political risk assessment used by MNCs is through the development of their own internal staff and in-house capabilities. This type of assessment may be accomplished by having staff assigned to foreign subsidiaries or affiliates monitor local political activities or by hiring people with expertise in the political and economic conditions in regions critical to the firms operations. Frequently, both means are used. The focus must be on monitoring political issues before they become headlines; the ability to minimize the negative effects on the firm-or to be the first to take advantage of opportunities-is greatly reduced once CNN has put out the news.
No matter how sophisticated the methods of political risk assessment become, however, nothing can replace timely information from people on the front line. In other words, sophisticated techniques and consultations are useful as an addition to. but not as a substitute for, the line managers in the foreign subsidiaries, many of whom are host-country nationals. These managers represent the most important resource for current information on the political envirronment and how it might affect their firm because they are uniquely situated at the meeting point of the firm and the host country. Prudent MNCs, however, weigh the subjectivity of these managers assessments and also realize that similar events will have different effects from one country to another.
An additional technique, the assessment of political risk through the use of computer modeling, is now becoming fairly common. One firm, American Can, uses a program called PRISM (primary risk investment screening matrix). This program digests information from overseas managers and consultants on 200 variables and reduces them to an index of economic desirability and an index of political and economic stability. Those countries with the most favorable PRISM indices are then considered by American Can for investment. Such a program, of course, is only as good as its input data, which is often of doubtful quality because of inadequate information systems in many countries and because the information is processed subjectively.
To analyze their data on potential risks, some companies attempt to quantify variables into a ranking system for countries. They use their staff or outside consultants to allocate a minimum and a maximum score for criteria they deem important to them (1. on the political and economic environment, (2. on domestic economic conditions, and (3. on external economic relations. The sum of the individual scores for each variable represents a total risk evaluation range for each country.
An actual risk ranking of selected countries for 1997 is shown in Exhibit 1-2. The country risk assessment is a comparative ranking of those countries based on factors such as GDP growth, trade policy, and foreign investment climate-that is, economic, not just political, factors. The comparison is on a scale of I to 5, with 5 being the highest ranking, or lowest relative risk. Thus, Russia and Turkey have the most risk in the overall rating of these countries, with Singapore and the Netherlands having relatively low risk.4
One drawback of these quantitative systems is that they rely on information based primarily on past events. They are therefore limited in their ability to predict political events in a volatile environment.
Still another method, more rapidly responsive to and predictive of political changes, is called the early-warning system. This system uses lead indicators to predict possible political dangers, such as signs of violence or riots, developing pressure on the MNC to hire more local workers, or pending import-export restrictions. The early-warning analysis is typically separated into macrorisk and microrisk elements.
In addition to assessing the political risk facing a firm, alert managers also assess the specific types of impact that such risks may have on the company. For an autonomous international subsidiary most of the impact from political risks (nationalization, terrorism) will be at the level of the ownership and control of the firm because its acquisition by the host country would provide the state with a fully operational business.43 For global firms, the primary risks are likely to be from restrictions (on imports, exports, currency, and so forth), with the impact at the level of the firms transfers (or exchanges) of money, products, or component parts.
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