Main types of political risks experienced by MNEs

Identify the main types of political risk encountered by multinational corporations and discuss how these risks can be minimized.

Introduction

The controversy between the Kazak government and the Italian oil company ENI about the exploitation of Kashagan´s oil fields is only one out of many cases, in which political violence acts or governmental decisions threatened foreign investments of a multinational enterprise (MNE). In April 2006, the Dacion and Jusepin oil fields, operated by ENI and the French company Total, were taken over by the Venezuelan government, because they rejected to change their business operations into joint ventures with the state-owned oil company PDVSA (Ferrari and Rolfini 2008).

Stated by Kesternich and Schnitzer (2009) some recent empirical studies identified that for MNEs political risk is one of the most important factors when considering a foreign investment. Foreign investments nowadays seem to be even more risky in terms of pollution that result in natural catastrophes such as caused by BP (Heller 2011), cultural conflicts or political disturbances for which Lybia (Yang 2011) represents a recent example and an increasing social disparity (Bloch, Koepplinger and Wolfrum 2007).

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However, the increased range of new opportunities, access to resources and lower costs through globalization draws companies to expand in foreign markets, nevertheless they find that politics of foreign countries add significant complexity and risk to their business performance (PriceWaterhouseCoopers and Eurasia Group 2006). As stated by Choudhry and Akhter (1995) “The growth of nationalist sentiments and the globalization of the world market have changed the parameters of the relationship between business and governments.”. However, foreign investment opportunities not only mean a higher level of risk but also can improve the global business performance such as the capitalization of opportunities resulting from political change or protection of new and existing global investments and operations of an MNE when managed appropriately (PriceWaterhouseCoopers and Eurasia Group 2006) In the following paper a definition of the term political risk is provided first, followed by an outline of the key political risks encountered by MNEs. In the second part recommendations about how to minimize such political risks are being discussed, before rounding off the picture with an overall conclusion.

Definition of the term “political risk”

Political risk can be defined as the entirety of conditions, decisions or events of governmental or political nature, which directly or indirectly (Hamada et al 2004) prevents or interferes with foreign business transactions, cause change of contractual agreements or even results in partially or wholly expropriation (Yaprak and Sheldon 1984). Such risks can be either classified in macro or micro risks (Albaum and Duerr 2008). Macro political risk on the one hand is country-specific and potentially influences all businesses situated in the host country such as terrorism, environmental regulations or civil war (Chapman 2006). On the other hand micro political risk affects for example the operations or the ownership of assets of a specific industry, company or project (Engineering Economist 2000). Within this framework Hamada et al (2004) suggests a categorization of political risk in three main types that are encountered by MNEs: expropriation, political violence and transfer risk and will be outlined in particular in the following section.

Outline of the main types of political risk encountered by multinational corporations.

Expropriation Risk

Expropriation or nationalization risk relates to losses caused by actions approved or taken by the host government in an arbitrary or even discriminatory way, which deprive the MNE of its control or even ownership of its investment. Expropriation without any compensation might result, in case of debt, bankruptcy if the MNE might not able to fulfil the obligations of its lenders (Yannaca-Small 2004). One type of statutory interference could be direct expropriation by entirely physical seizure or formal assignment of the legal title or patent rights (Ferrari and Rolfini 2008). The most threatening type of expropriation for MNEs according to Hoffman (2007, p.48) “…takes place over time in a series of so called creeping acts that collectively result in an expropriatory act.”. Creeping expropriation is the type of risk, by which the host government deploys a combination of additional fees or taxes and other devices and charges to increase its share of the companies or projects profits after the company has made its investment (Hoffman 2007). Furthermore, host governments also try to renegotiate contractual agreements with MNEs or even change policies once the investment has been made (Gatignon and Anderson 1998, Williamson 1996). In the 1970s for example, IBM and Coca-Cola both left India because of the statutory restrictions that came up after they already made initial investments. IBM left India because the government demanded it to share its technological innovations with local competitors and Coca-Cola was required 1. to transfer 60% of its equity to an Indian company 2. to unveil its secret formula and 3. to use twofold trademarks for the Indian consumers so that they would acquaint themselves with a local emblem. All of the governmental demands were utterly rejected by Coca-Cola. The company feared expropriation by unveiling its secret formula once the new trademark would become accepted and left the country as well (Minor 2011).

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