What are the different ways of managing political risk? Discuss.

 Management of Political Risk: Having analyzed the political environment of a country and having assessed the risk to its operations, a firm should decide

(a) Whether to invest is that country. 

(b) If so, how to device coping strategies to minimize the risk.

Pre-investment Planning: An MNC can follow each or all of the following policies:

(1) Avoidance

(2) Insurance

(3) Negotiating the Environment

(4) Structuring the Investment.

(1) Avoidance: Many firms tackle the political risk by avoiding investing in that country. The issue is what amount of risk, the company finds acceptable and is prepared to bear.

If the firms avoid investing in a high risk country, it also foregoes the high returns possibly available on its investment.

Thus most multinationals use avoidance strategy only rarely and try to recognize and assess the risk, e.g., investing in dictatorial China, or economically volatile South Asian countries is risky.

However, if the risk does not materialize, the returns are considerable.

(2) Insurance: Most developed countries sell political risk insurance to cover foreign assets of domestic companies. 

Many multinational corporations take advantage of it.

Mostly high-risk multinationals will seek insurance. Hence, adverse incentives are built in by adjusting premiums in accordance with the perceived risks.

Screening out certain high risk applicants and by providing reduced premium to the companies engaged in activities that are likely to reduce expropriation risk.

(3) Negotiating the Environment: There are two fundamental problems with relying on insurance as a protection from political risk. First, there is an asymmetry involved. If an investment proves unprofitable, it is unlikely to be expropriated.

Since business risk is not covered, any losses must be borne by the firm itself. On the other hand, if the investment proves succes and is expropriated, the firm is compensated only for the value its assets.

Thus, although insurance can provide partial protec from political risk, it is not a comprehensive solution. 

At times firms try to reach an understanding with the host government before undertaking an investment.

This is called a “concession agreement” in which rights and responsibilities of both parties are defined. These concession agreements are negotiated by multinational firms with developing countries.

However, as the experience in developing countries shows, such concession agreements are difficult to implement, particularly in countries like Iraq, Iran, etc.

(4) Structuring the Investment: Multinational firms try to increase the cost of interference by the host country to minimize its exposure to political risk.

This can be done by keeping the local affiliate dependent on sister companies for markets and supplies. 

Another strategy is to establish a single global trademark that cannot be legally duplicated by a government. Control of transportation is user by some companies to prevent any adverse action on their projects by the lost government.

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