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Chapter 11: Political Risk

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

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  1. Chapter 11: Political Risk Keith Head Sauder School of Business UBC

  2. 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.

  3. 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.

  4. 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

  5. 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?

  6. Insurable Risks • expropriation • “non-repossession” • war and political violence • cancellation of operating licences • exchange transfer problems • import and export embargoes

  7. 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

  8. 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.

  9. 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

  10. 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

  11. 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)

  12. 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.

  13. 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

  14. 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

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