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Chapter 11: Political Risk. Keith Head Sauder School of Business UBC. Take-away. Political risk analysis is the attempt to predict tomorrow’s “hot spots” and then avoid them, insure against losses, or prepare to minimize loss through rapid exit.

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chapter 11 political risk

Chapter 11: Political Risk

Keith Head

Sauder School of Business

UBC

take away
Take-away
  • Political risk analysis is the attempt to predict tomorrow’s “hot spots” and then avoid them, insure against losses, or prepare to minimize loss through rapid exit.
  • Political risk strategy follows a 4-step plan to influence host government actions.
analysis vs strategy
Analysis vs Strategy
  • Analysis: When the actions of host governments are beyond the influence of individual firms, like the weather.
    • Risk is exogenous.
  • Strategy: When the MNE’s actions have an important influence on the host government’s decisions.
    • Risk is endogenous.
responses to exogenous risk
Responses to Exogenous Risk
  • Forecast the “hot spots”* and avoid them.
  • Invest in potential hot spots, but prepare in advance for rapid evacuation.
  • Invest in potential hot spots, but insure investments against possible losses.

*Hot spot: an area of political, military, or civil unrest usually considered dangerous

questions re on coups and coverage
Questions re “On coups and coverage”
  • Where do the dangers lie? Which countries are “hot spots”?Aon 2009 Risk Map
  • What events can be insured against?
  • Who provides the insurance?
  • How common are disputes?
  • How common are payouts on claims?
  • Are all risks insurable?
insurable risks
Insurable Risks
  • expropriation
  • “non-repossession”
  • war and political violence
  • cancellation of operating licences
  • exchange transfer problems
  • import and export embargoes
case studies in political risk
Case studies in Political Risk
  • Metalclad in Mexico
  • Hugo Chavez and foreign firms in Venezuela
    • Orinoco oil basin (ExxonMobil)
    • Sidor, the steel maker
    • banks
  • Enron in India
  • Bre-X in Indonesia
  • Lithium in Bolivia
political strategy a 4 step plan
Political Strategy: a 4-step plan
  • Understand host government’s objectives.
  • Catalogue host government’s policy options.
  • Calculate host government’s bargaining power.
  • Enhance the MNEs strategic position.
1 what do host governments want from foreign investors
1. What do host governments want from foreign investors?
  • Capital inflow
  • Tax revenue
  • Job creation
    • More jobs
    • Better jobs (high wages)
  • “Improvement” in trade balance (net export outflow)
  • Technology (intellectual capital) inflow
2 how do governments get what they want from the mne
2. How do governments get what they want from the MNE?
  • Jobs:
    • minimum employment
    • restricted use of expatriates
    • incentives to choose backward areas
  • Improved trade balance:
    • Export requirements
    • Domestic content requirements
  • Technology transfer:
    • Forced use of local joint venture partners
3 what gives a government the bargaining power to get what it wants
3. What gives a government the bargaining power to get what it wants?
  • Uniquely valuable country characteristics
    • A large, protected market
    • A scarce natural resource
  • Investment decisions by the MNE that are irreversible (or very costly to reverse)
4 how can the mne improve its own strategic position
4. How can the MNE improve its own strategic position?
  • Make “friends” with powerful people
  • Strategic Delay
    • MNE can punish host gov’t by cancelling investments that have not been done yet
    • Holding back even when it is inefficient
  • Make “credible threats”*
    • Invest in strategic alternatives
    • Build a reputation for toughness

*credible threats: promised responses that are not bluffs,

the firm really will follow through.

is the mne s threat credible
Is the MNE’s threat credible?

MNE

payoff

Host Gov’t

payoff

Keepplant

-5+10=5

17-10=7

Approve

$10m subsidy*

MNE

-15

0

Host Gov’t

Shut plant

Keep plant

Deny

$10m subsidy

-5

17

MNE

0

Shut plant

-15

*subsidy not paid if firm shuts plant

strategic alternatives make the threat credible
Strategic alternatives make the threat credible

MNE

payoff

Host Gov’t

payoff

Keepplant

-5+10=5

17-10=7

[-5=0]

Approve

$10m subsidy*

MNE

-15

0

Host Gov’t

Shut plant

[+10=-5]

Keep plant

Deny

$10m subsidy

-5

17

[-5=-10]

MNE

0

Shut plant

-15

[+10=-5]

*subsidy not paid if firm shuts plant