The Political Imperative in International Business: Political and Country Risk

1
The Political Imperative in International
BusinessPolitical and Country Risk

• Timothy Devinney

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The ImperativesA General IBS Framework
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What is Political Risk?

• Discontinuities occurring in the business
  environment that are
• Difficult to anticipate
• Result from political action(s) or changes(s)
• That possess the potential to significantly
  affect profit or business goals

Note Political risk may be related to political
instability but it need not be
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Political Risk, Country Risk and Project Risk
Political Risk
Country Risk
Project Risk
Government Action
Social Institution Action
Firm Action
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Political Interest Politics
Requests for Special Treatment
Government
Wealth creating entities
Special Interest Groups
TAX

• Indirect taxes
• Difficult to see how much is being taxed and
  where benefits are going
• Differential taxation of non-citizens

Direct and transparent taxation
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Determinants of Political Reaction
Political Reaction
Social Environment
Business Environment
External Business, Social Political Environment
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Risk and Uncertainty
Total Uncertainty
Objective Uncertainty Subjective Uncertainty
Objective Uncertainty
Subjective Uncertainty
Uncertainty about the probability of an outcome
Uncertainty about the probability of an outcome
due to limited information, differences of
opinion, prejudice, etc.
p
Probability of an Event
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Estimated and Actual Risk
Natural World
Actual
RISK
Assessment of the Natural World
Estimated
Political Instability
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The Dimensions of Political Risk
Focus of Risk
Risk of expropriation of all or part of
ownership e.g. nationalisation or JV
requirements
Risks associated with the physical operations
e.g. environmental regulation
Uncertainty or region surrounding the flows to
and from the country e.g., profits or technology
Ownership
Operational
Transfer

Micro
Macro
Risks affecting all firms in a country or region
Risks specifically targeted at a firm, industry
or nationality
Scope of Risk
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The Components of Project-Country Risk
Total Project-Country Risk
Project Specific Risk
Country/Political Risk
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Measuring Political RiskWhich Modeling
Technique?
Macro
Quantitative Models Econometric Causal Models
Delphi Hybrid Models
Qualitative Models Grand Tours Old Hands
Micro
Few Countries
Many Countries
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Quantitatively Assessing Political Risk
POLITICAL SYSTEM STABILITY INDEX
Socio-economic Characteristics Index
Governmental Processes Index
Societal Conflict Index
Internal Violence Index
Public Unrest Index
Political Coercion Index
Ethnolinguistic Fragmentation GNP Growth Energy
Consumption
Riots Demonstrations Govt. Crises
Armed Attacks Assassinations Coups d'etat
Guerrilla Activity
Political Competition Index Legislative
Effectiveness Constitutional Changes Irregular
Chief Executive Changes
Internal Security Forces per 100k
DATA
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Quantitatively Assessing Political Risk
Societal Conflict
Somalia,
Former
Mozambique
Yugoslavia
Public Unrest
Internal Violence
Coercion
Brazil
Socio-economic
Governmental Processes
Developed Asian Economies
Developed Western Economies
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Causal Modeling
High Prices
Personal Taxes
Corporate Taxes



-

Political Regulation of the Marketplace

-



Heavily Unionized Labor Sector
Heavy Cross-Ownership of Companies and Banks
Youth Labor Force Activity
-

-
Disaffected
All -
Wages
Workers
Dividends


Female Labor Force Activity
Thinly Traded Securities Markets
Productivity
-
Bold
implies an unobserved construct

Access to Capital by Small Firms
The direction of the arrow implies causality
The -/ implies the direction of the effect
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An Example of a Mixed Model (Euromoney)
Weighting in the Risk Index
10 Economics 20 Politics 10 Debt 10
Bank Lending 10 Short Term Lending 10
Capital Markets 10 Discount Rate 10 Credit
Rating 10 Default Rate
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An Example of a Mixed Model (Euromoney)
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Pluses/Minuses of Political/Country Risk Measures

• Qualitative Models
• PlusCurrent and able to synthesize
  non-quantifiable information
• Minusad hoc lacking in verifiability and not
  comparable across countries inability to compare
  experts
• Quantitative Models
• PlusMore accurate and generalizable
  quantification of the factors underlying risk
  subject to scientific validation
• Minuslimited to measurable information tendency
  to view risk as a linear and uni-dimensional
  construct reliance on data can make them dated

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What Should You Do with All of This Information?

• Decision Theory shows that pooling of forecasts
  always dominates individual forecasts
• E.g., the average of ten forecasters will, on
  average, beat the average error of the ten
  individual forecasters!
• Why?
• Forecasters tend not to be unbiased. Pooling
  forecasts takes out the tendency to be biased and
  balances overly optimistic with overly
  pessimistic forecasts.
• Pooling of forecasts drives the subjective
  component of uncertainty to zero.

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Managerial Responses to Political Risk
Forecasting
Reduction of Subjective Uncertainty
Forestalling

• Outward FDI
• Pro-Active Public Relations
• Bribery or Political Lobbying
• Reputation e.g. Following a
• Strategic Disposition or
• Tit-for-Tat Strategy

Structuring the Company and its Strategy to
Control/Mitigate the Impact of Unpredictable
Events

Absorption

• Joint VenturesParticularly with State Companies
• Pre-emptive FDI
• Vertical Integration

Internalisation of Political Risk Through the
Structuring of the Company
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Managerial Response to Political Risk
(Gladwin/Walter bargaining framework)
High
High
Competitive
Collaborative
Assertive
(Domination)
(Integration)
Compromise
OUTCOME STAKES
RELATIVE POWER
BEHAVIOR
(Sharing)
Unassertive
Avoidant
Accommodative
(Neglect)
(Appeasement)
Low
Low
BEHAVIOR
Uncooperative
Co-operative
RELATIONSHIP QUALITY
Negative
Positive
INTEREST DEPENDENCE
Negative
Positive