Class Notes 11

Takeaways

Momo Deretic
Sauder School of Business
 Responses to Exogenous Risk
Anticipate
Prepare
Insure
Litigate/arbitrate
Risk definitions: Political Risk Insurance (EDC)

Breach of contract risk: The breach of a contractual obligation by a foreign

government or state-owned entity and the ensuing refusal by the government or
entity to honour an arbitral award in your favour.
Non-payment by a sovereign obligor: The refusal or inability of a foreign
government to make scheduled loan payments or to make a payment under a
guarantee.
Expropriation risk (including gradual or creeping expropriation): An act or
a series of acts taken by a foreign government to seize, confiscate or otherwise
expropriate your assets or investments, or foreign government acts that have
had the effect of expropriation.
Political violence risk: Terrorism or other forms of political turmoil aimed at
influencing the policies of the host country government that damage assets or
force you to shut down foreign operations.
Conversion risk: The inability to convert the local currency of a foreign country
into hard currency.
Transfer risk: The inability to transfer hard currency outside a foreign country.
Repossession risk: Measures that a foreign government may take that prevent
you from repossessing or re-exporting physical assets brought into the country
(e.g. machinery, equipment, rolling stock, an aircraft, etc.).
 Political strategy: a four-step plan
1. Understand host governments
objectives.
2. Catalogue host governments policy
options.
3. Calculate host governments bargaining
power.
4. Enhance the MNEs strategic position.
 1. What do host governments want
from foreign investors?
Job creation
More jobs
Better jobs (high wages)
Technology (intellectual capital) inflow
Tax revenue
Improvement in trade balance (more
exports, capital inflow)
 2. How do governments get what they
want from the MNE?
Jobs:
investment incentives
minimum employment
restricted use of expatriates
Domestic content requirements
Improved trade balance:
Export requirements
Domestic content requirements
Technology transfer:
Forced use of local joint venture partners
Domestic content requirements
 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?
Make friends with powerful people
(lobbying, use local partners, etc.)
Strategic Delay
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.
 Major takeaways
Host governments are very powerful over
the territory they govern. They are the
gate keepers and MNCs operate in the
host country based on the approval of
these governments, which can be
withdrawn without warning.
MNCs should take precautions when
predicting and calculating the sovereign
risk and design a strategy to minimize this
risk.