International Business Strategy, Management & the New Realities by Cavusgil, Knight and Riesenberger

1. International BusinessStrategy, Management & the New Realitiesby Cavusgil, Knight and Riesenberger Chapter 6 Political and Legal Systems in National Environments International Business: Strategy, Management, and the New Realities

2. Country Risk Exposure to potential loss or adverse effects on company operations and profitability caused by developments in a country’s political and/or legal environments. Also referred to as ‘political risk’. Each country has a unique political and legal system that may pose challenges for company strategy and performance International Business: Strategy, Management, and the New Realities

4. What Gives Rise to Country Risk? • Immediate cause is a political or legal factor, but economic, social, or technological developments may be the root cause. • Laws may be unexpectedly strict, political/ legislative actions may harm business (even though not the intent). • Example - In China, the government censors material that criticizes the government. Yahoo must monitor the information that appears on its Web site to prevent the Chinese government from shutting down its China operations. • Weak law enforcement is also often a factor. International Business: Strategy, Management, and the New Realities

6. What are Political and Legal Systems? • Political system - a set of formal institutions that constitute a government and how these groups interact with each other. Includes legislative bodies, political parties, lobbying groups, and trade unions. • Legal system - a system for interpreting and enforcing laws and regulations. Includes institutions and procedures for ensuring order and resolving disputes. International Business: Strategy, Management, and the New Realities

7. Three Major Types of Political Systems • Totalitarianism • Socialism • Democracy These categories are not mutually exclusive. E.g., most democracies include some elements of socialism. International Business: Strategy, Management, and the New Realities

9. Totalitarianism • Government controls all economic and political matters. • Either theocratic (religion-based) or secular • A state party is led by a dictator. Membership is mandatory for those wanting to advance. • Power sustained via secret police, propaganda, regulation of free discussion and criticism. • Examples: China (1949–1980s), Germany (1933–1945), Soviet Union (1918–1991), and Spain (1939–1975). • Today, some states in the Middle East and Africa employ totalitarianism. • Many ex-totalitarian states have much government intervention, red tape, and bureaucracy International Business: Strategy, Management, and the New Realities

10. Socialism • Capital and wealth vested in the state and used primarily as a means of production for use rather than for profit. • Group welfare outweighs individual welfare. • Government’s role is to control the basic means of production, distribution, and commercial activity. • Socialism occurs in much of the world as social democracy (e.g., Western Europe, Brazil, India). • Frequent government intervention in the private sector. • Corporate income tax rates are higher. International Business: Strategy, Management, and the New Realities

11. Two Key Features of Democracy • Privateproperty rights: The ability to own property and assets and to increase one’s asset base by accumulating private wealth. Property includes land, buildings, stocks, contracts, patents. Encourages initiative, ambition, innovation. • Limited government: The government performs only essential functions that serve all citizens, such as national defense, maintaining law & order, foreign relations, and providing basic infrastructure International Business: Strategy, Management, and the New Realities

12. Democracy’s Link to Economic Freedom • Empirical evidence suggests that democracy -- greater economic freedom –leads to higher economic living standards. • Economic freedom flourishes in systems characterized by: • Free market economics • Strong ‘rule of law’ • Minimal government intervention in business International Business: Strategy, Management, and the New Realities

14. Command (Centrally Planned) Economies ● The state is responsible for making all decisions: what goods and services the country produces; quantity of production; prices at which they are sold; and distribution. ● The state owns all wealth, land, and capital, and allocates resources based on which industries they want to develop. ● Common in the 20th century, command economies proved so inefficient that most have gradually died out. ● Central planning is less efficient than market forces in synchronizing supply and demand. ● Today many countries exhibit some characteristics of command economies; e.g., China, India, Russia, and certain countries in Central Asia, Eastern Europe, and Middle East. International Business: Strategy, Management, and the New Realities

15. Market Economies and Mixed Economies In market economies, • Decisions are largely left to market forces, the interaction ofsupply and demand. • Individuals and firms are main decision-makers. • Government intervention is limited. • Associated mainly with Capitalism Mixed economies have features of both market and command economies, combining state intervention and market mechanisms (e.g., Sweden, Singapore) International Business: Strategy, Management, and the New Realities

16. Five Types of Legal Systems The five legal systems are the foundation for laws and regulations: • Common law • Civil law • Religious law • Socialist law • Mixed systems International Business: Strategy, Management, and the New Realities

18. Common (Case) Law • A legal system that originated in England and spread to Australia, Canada, USA, and other former members of the British Commonwealth (also known as case law). • The basis of law is tradition, past practices, and legal precedents set by courts via interpretation of statutes, legislation, and past rulings. • Judges have much power to interpret laws based on the circumstances of individual cases. Thus, common law is relatively flexible. International Business: Strategy, Management, and the New Realities

19. Civil (Code) Law • Found in France, Germany, Italy, Japan, Turkey, and much of Latin America. • Based on an all-inclusive system of laws that have been “codified”, clearly written by legislative bodies • Laws are more ‘cast in stone’ and not strongly subject to interpretation by courts * * * * * * * * A key difference between civil law and common law is that common law is mainly judicial in origin and based on court decisions, whereas civil law is mainly legislative in origin and based on laws passed by legislatures International Business: Strategy, Management, and the New Realities

21. Religious Law • Strongly influenced by religious beliefs, ethical codes, and moral values, viewed as mandated by a supreme being. • Most important religious legal systems are based on Hindu, Jewish, and Islamic law. • Islamic law spells out norms of behavior regarding politics, economics, banking, contracts, marriage, and many other social and business issues. International Business: Strategy, Management, and the New Realities

22. Socialist Law • Found mainly in China, former Soviet Union, and a few states in Africa • Based on Civil Law, with elements of socialist principles that emphasize state ownership of property -- state rights take precedence over individuals’ • Tends toward loose treatment of property and intellectual property rights International Business: Strategy, Management, and the New Realities

23. Actors in Political and Legal Systems • The government, or the ‘public sector’,is the most important actor, operating at federal and local levels. • Supranational agencies such as the World Trade Organization, United Nations, and the World Bank • Regional trade organizations, such as the European Union (EU), the North American Free Trade Agreement (NAFTA), etc. • Special interest groups such as labor unions and environmental groups • Local competing firms oppose foreign firms, and lobby their governments accordingly. International Business: Strategy, Management, and the New Realities

25. Country Risk Produced by the Political System:Government Takeover of Corporate Assets • Confiscation:seizure of foreign assets without compensation. E.g., Venezuelan President Hugo Chavez confiscated a major oil field owned by French firm Total. • Expropriation: seizure of corporate assets with compensation. • Nationalization: government takeover of an entire industry, with or without compensation. In 2006, the government of Bolivia nationalized much of the country’s oil and gas industry. • Privatization: selling state-owned enterprises to private interests. International Business: Strategy, Management, and the New Realities

26. Country Risk Produced by the Legal System • Foreign investment lawsaffect the type of entry strategy firms choose, as well as their operations and performance. Nations impose restrictions on inward FDI, such as Japan’s large retail store law or the U.S. and Dubai Ports World • Controls on operating forms and practices affect firms’ production, marketing, and distribution activities. E.g., China requires market entry via joint venture in its huge telecommunications sector. International Business: Strategy, Management, and the New Realities

27. Country Risk Produced by the Legal System • Marketing and distribution laws determine which practices are allowed in advertising, promotion, and distribution. E.g., laws may restrict TV advertising aimed at children. • Laws regarding income repatriation limit the amount of net income or dividends that firms can bring back to the home country. • Environmental laws are intended to preserve natural resources, combat pollution, and ensure health and safety. E.g., in Germany, firms must follow strict recycling regulations. International Business: Strategy, Management, and the New Realities

28. Country Risk Arising from the Home-Country Legal Environment • Extraterritoriality: application of home-country laws to other countries. E.g., the European Union has pursued Microsoft for perceived monopolistic practices. • Foreign Corrupt Practices Act (1977) made it illegal to offer bribes to foreign parties. But, definition of a “bribe” is unclear; Harms U.S. interests because foreign competitors are not so constrained. International Business: Strategy, Management, and the New Realities

29. Accounting and Reporting Laws Differ widely around the world. Examples: • Physical asset valuations: Canada and the U.S. use historical costs. Some Latin American countries use inflation-adjusted market value. • Uncollectible accounts allowance: in the U.S. – yes; France, Spain, and South Africa – no • Research and development costs are: expensed as incurred in most of the world; Capitalized in South Korea and Spain; Belgium, Malaysia, and Italy use both conventions. International Business: Strategy, Management, and the New Realities

30. Transparency in Financial Reporting Transparency -- degree to which firms regularly reveal substantial financial & accounting information • Timing and transparency of financial reporting vary widely around the world. • Sarbanes-OxleyAct (2002) promotes greater transparency in accounting practices. But, cost of compliance is high; Discourages foreign firms from listing or transacting extensively in the U.S. International Business: Strategy, Management, and the New Realities

31. Ethical Values and Practices Ethics refers to the moral behavior of people, firms, or governments- issues often arise, or may be exacerbated, by deficiencies in legal systems. Corruptiontypically involves the use of bribery and fraud to achieve business goals. Most common in developing economies. International Business: Strategy, Management, and the New Realities

32. Contract Law Local contract law is a factor in five types of contracts: • Sale of goods or services; • Distribution via foreign intermediaries; • Licensing and franchising; • Foreign direct investment; and • Joint ventures. International Business: Strategy, Management, and the New Realities

33. Protection through Legal Contracts • A legal contract spells out the rights and obligations of each party; especially important when relationships go awry. • Three approaches for resolving contractual disputes: • Conciliation is the least adversarial method; a formal process of negotiation that aims to resolve differences in a friendly manner. Common in China. • Arbitration is a process in which a neutral third party hears both sides of a case and decides in favor of one party or the other, based on an objective assessment of the facts. • Litigationis the most adversarial approach, and occurs when one party files a lawsuit against another; Most common in the United States. International Business: Strategy, Management, and the New Realities