Effects of Political Risk on Business Stability - Coursework Example

Effects of political risk to the business stability of a nation and methods of managing these risks Name Instructor Institution Subject Date Introduction The political environment in a country has huge implications to international businesses. A political system is inclusive of political organizations, institutions, and governs the relationships between its citizens (Baas, 2010: 138). The political system must therefore, align the interests of all groups towards achieving a self-governing society. In addition, it must be able to unite and protect the society against pressures and competing ideologies. In most cases, the investors consider the political perils as of their main factor in investing in a given country. While it appears that the corporate investors continue to be sanguine in the prospects of the investments, Boulos (2009) pointa out that, the political risks turn out to be one of the major concerns even as the perils which relates to the crisis fall out as, the global economy continues to recover. Previously, it was thought that political risks were only for investors in the industrialized countries. However, it has come out as pinpointing issues in the emerging market. Essentially, weak political systems are characterized by corruption, lawlessness, lack of functioning capital markets, rampant inflation, and lack of productive investment opportunities as put forward by Adel Al Khattab (2010). Assessing corruption issues in the desired country is crucial to a firm’s success. Countries that exercise democracy are associated with a high level of foreign investment unlike in the authoritarian countries that have political unrest such as Vietnam (Government in brief, 2011). In contrast, studies by Boulos (2009) show that, democratic countries are not always preferred to authoritarian regimes for investors. The rapid growth of international businesses has seen many companies crossing national borders in search of unexploited opportunities. Understanding and dealing with political risks is critical aspect for companies working internationally. Political risks Political risks can be traced back from the World War era. After the World War 11, political risk posed a major challenge to companies wishing to invest in foreign countries (World Bank, 2010). This was because; the newly formed independent nations required a major role in controlling their resources. Companies wanted to invest only in nations where the risk of nationalization deemed relatively low (Boulos, 2009). It had been conceptualized as a matter in which the government had breached contracts, presence of restrictions on the currency transfer, political violence. Today, however, nationalization is no longer a major issue. The globalization of international businesses has made it possible for companies to operate in any part of the globe they desire. Some host governments interfere with normal business operations by insisting on specific ways of running the business. This adds considerable pressure, uncertainty and increases the risk of conducting business in such environments (Harms, 2000: 1040). Governments can frustrate the bidding processes by favoring domestic bidders and ignoring the foreigners. Since they are in foreign markets, businesses have little influence on the way the business is operated. The host government may change laws and taxes, change local standards and at times, even delay payments to foreign investors. Additionally, political risks can be defined as risks that result from political decisions, policies, and rulings of a country. Most of these risks affect the country’s economy without sparing the business environments. These risks affect negatively businesses’ profitability and sustainability. The components of political risks assessment include; government stability, ethnic conflict, corruption, and investment profile (Kumar, 2009). These assessments have transitioned from focusing on the host country to various stakeholders that could have an effect on the investment. These stakeholders include; ethnic groups, sub-national entities and domestic and international civil society groups. Recent times have seen rise in ethnic conflicts especially in developing countries. For instance, in Russia and Brazil, the focus on political analyst has been on how given leadership may change the stability of a given country as noted by Henisz and Zelner (2010). These conflicts have a significant impact on business operations. This has been due to the political risks caused by government decisions and actions, civil unrest and change in political ideologies. Consequently, high levels of political risks are associated with countries experiencing social unrest and a political violence. Countries associated with lower political risks are most favored by businesses since they have better opportunities. Harsh government decisions can affect a country’s attractiveness. Import restrictions, high and discriminatory taxes, and levies policies on foreign businesses reduce its attractiveness to foreign investors. The need to expand their products and pursue new markets and additional customers forces companies to open their distribution outlets in foreign countries. The search of lower costs of resources and production has made companies expand into international markets. Before doing so, they must do a political analysis of the desired country (Boulos, 2009). When done wisely, this may become the companies’ stronghold. Challenges due to political risks However, some countries have harsh politics and this may complicate the operation of new businesses. When making decisions about activities in other countries, multinational companies should also assess the chosen country’s government political stability. The companies foresee potential changes in the treatment of foreign corporations. Local instability in the host country may lead to disturbance, hence, negatively affect schedule. Social unrest may cause interruption to the supply of materials and personnel. Foreign investors face challenges when obtaining permits and licenses to conduct business in the host countries. This is more so in countries that have weak and corrupt political systems. As hypothesized by Sheeran and Amber (2004), permits and licenses of operations are given, not on merit but on who has more influence and power. Local authorities lack transparent methods o awarding tenders; only the influential business figures get the tenders even when they have doubtful past records. Companies choose politically attractive countries when they decide to go international. Multi-national companies often avoid high-risk countries, and try to limit their exposure to political risks. When a country is experiencing civil unrest, it can lead to the destruction of company assets. Most international companies halt their normal operations during these detrimental times. This in turn, affects the companies’ operations and profitability (Adel Al Khattab, 2010). Countries that are rich in resources, such as oils reserves are faced with continuous political risks. Investing in such industries involves higher levels of these risks. For example, government tend to demand an increase of its share of revenues when oil price rise. The link between economic growth and political instability has negative impacts on the investment environment. The impacts of political risks are adverse and devastating at the same time. Not only do they cause loss of property, they also cause misallocation of capital and loss of opportunity. These losses and liabilities affect the normal operations of businesses and reduce profits. This may lead to severe financial hardships, and at times make companies go bankrupt. How to assess political risks Emerging markets are becoming major targets for foreign investments. As businesses expand, they experience changes in every aspect of their operations. As noted by Brink (2004), such rapid change also leads to increased exposure to risks. Corporations are exposed to a variety of risks, and political risks can jeopardize the operations of international companies. Investments are increasingly being subjected to a range of risks that include unstable governments, terrorism threats, and political violence. To counter these challenges, companies require high-quality political risk and business intelligence (Kumar, 2009). The primary objective behind a country’s political analysis is to minimize the downside risk. In addition, the assessment seeks to isolate sources of potential volatility in a country’s economic environment. The assessment evaluates the creditworthiness of nations and evaluates the performance of private, foreign entities. Methods of assessing risks vary widely across different types of businesses and industries. Some sensitive businesses manage political risks in a highly quantified way (Click, 2005: 559-567). Failure to manage these risks successfully could result in highly undesirable outcomes. Analysis of a political risk of a country is a well-established field within the international business research. By doing so, companies demonstrate a clear relevance to practice. The companies must be in a position to assess political risks in countries they wish to invest. it is wise to do this before investments have been made. These risks are associated with investing capital and holding assets in the desired countries. To achieve this, they must analyze past political trends of the desired country. Predictions must be obtained based on these past situations. Companies may also find it critical to obtain expert opinions since it may be difficult for them to access and evaluate this information on their own. They need information they can act on and therefore, they need to choose their sources of information. Knowing that they are operating in politically turbulent times, these companies need to consider opinions from several bodies in order to obtain reliable and accurate information (Adel Al Khattab, 2010). However, independent sources should be chosen, as they are deemed more reliable. The sources include embassies, academicians, internet, business analysts, newspapers, published reports, and appropriate government authorities. Additional sources include chambers of commerce, banks, and trade associations. When thoroughly researched, these sources provide un-biased, broad, and in-depth overview of the political situation of a country. The information should help fill any gaps in the strategic decision-making mechanisms in order to reap maximum profits. Methods that international businesses manage political risks In the operation of any business, it is inevitable to encounter unexpected and unpleasant financial surprises, which may threaten to destroy or even undercut the business as indicated in table 1. However, as stipulated by Bracken and Ian (2008), the essence of these risks is how the business reacts upon them. When international businesses ventures into a particular country, most of them focus on creating public relation campaigns that tend to boost their names. However, Clark, Adam and Ashby (2009) claim that, they are supposed to focus on the political spin by presenting their views as an equitable and fair firm. This would attract more political support than just giving the cost benefit analysis. The respond determines whether the business survives or succumbs to the pressure. Business should make use of political risk to gain advantage over their competitors. The speed in which they respond to the changed circumstances may enable them to turn threats into opportunities (Boulos, 2009). Table 1 Reason why firms manage political risks Reason percentage Avoid financial surprise 75 Anticipate change in political leadership 39 Influence government policy 19 Participate social change 18 Lower insurance premium 18 Source (Henisz, W. and Zelner, B. 2010) Different industries have different risk profiles and therefore, require different approaches when managing their impacts. Some of the risks are predictable and can be easily be put under control by the management. There are also those that are unpredictable and uncontrollable. Despite all these, companies can still effectively manage political risks facing their businesses. Increased concerns about political risks have given rise to various management methodologies. Most of these methodologies identify and mitigate risks by focusing on them as soon as they occur. Mitigating is a critical component of risk management as it lessens their impact. A well-planned and implemented mitigation program should reduce adverse effects political risks may have on businesses. Political mitigation techniques are strategic components to business risk-management. This is evident in the Korean wireless market whereby, the LG telecom which was entering the market called for government regulation so as to level off the playing field which other competitors such as the Korean telecom and SK telecom. Uncertain government environments and political violence are becoming common scenarios in the present volatile economic environment. Positive returns on investments are directly influenced by decisions on the level of risk to take in new investment and how well is both risks are assessed and dealt with. Firms, which are superior risk-takers usually, generate higher returns for longer periods on new investments (David, 2002; Clark et al., 2009). Increased exposure to political risks translates to higher costs of capital especially for firms with diversified investors. A good political risk should have its positive effects outweighing the negative consequences. A company wishing to manage these risks can adopt various mitigation strategies. The selection of proper strategy depends on characteristics of the company and the available resources. The adopted strategy should cushion the company and enable it to absorb greater risks. They include retention strategy, control strategy and transfer strategy. Retention strategy can be implemented when a decision is made to accept the cost should the event occur. Through the control strategy, the company develops a risk management plan while closely monitoring and correcting it where appropriate. The transfer strategy is when the company makes a decision to place liability for a loss on a different party via a contract. A good example is getting insurance covers for the company against political risks. The company pays a monthly premium in exchange for protection against damages caused by politically related risks. Foreign investors should work with other participants in the region, local governments and security personnel to provide secure working environment Since managing political risks is a complex process, commitment from the top-level management is required. The management should take control of the process and align its efforts towards minimizing or protecting their companies from political risks. They can institute processes that enable resources and employees across the company to participate in identifying political risks. Top-level managers are responsible for monitoring and controlling political risks. They must actively set and closely monitor the risk assessment framework in order to make sound decisions for their companies (Kumar, 2009). Owners and top managers should show their support for employees’ efforts at managing risks. The assessment should look beyond individual projects; it should concern itself with how to structure portfolios. Each risk should be considered as unique and addressed with tailored approaches. Companies should perform periodic reviews of the programs in place. They should evaluate their current approach to managing political risks and check whether it is still effective, and if the desired result is being achieved. If the approach is found to be effective, the management may decide to keep and do improvements in lacking sections. However, if the approach is outdated, the company should consider developing and replacing the old approach. The new approach should be in a position to meet the current demands of the company. Companies should develop systematic, structured, and rational approaches when managing political risks. This is because political catastrophes cause irreversible harm to the operations of the business. Through effective management, companies can guard their assets and maximize on new opportunities that may not otherwise have seen. As a result, the companies are able to improve their performance in the foreign lands. Executives of international companies should understand how best to analyze political risks. They should then use this knowledge to help their companies’ general performance in the foreign countries. As noted by Rubins and Stephan (2005), they may develop risk mitigation tools to control the devastating effects that political risks cause their businesses. Furthermore, they should assess political statements concerning foreign businesses made political leader. These statements normally reflect on the leaders’ feelings, and attitudes towards foreign investors. They should also collect political data, such as the number of uprisings in the past decade. This may be aid them arrive at an aggregate measurement of the country’s risk (Boulos, 2009). This way, the investors get a different perspective on the attractiveness for investments. The process of gathering information should be a continuous; it should not stop at the initial stages. Companies should not rely on outdated information since it can have negative impacts on the business. In addition, old information can lead to making inappropriate business decisions. Multinational companies should consider setting up early-detection systems when operating in high-risk countries. According to Khattab, John and Eleanor (2008), the system should identify and forecast political events that may affect the company and the country. It is crucial to evaluate the probability of an event occurring and come up with strategies on how to counter such cases. In addition, the forecast should establish the company’s ability to withstand shocks caused associated with political risks. As a result, the company will be in a position to attract and retain only strongly attuned suppliers. Consumer product companies, in the other hand should analyze short-term risks such as strikes and protests. For example, social disturbances could cause problems in the transportation of products from the suppliers to the consumers. These risks could affect their brand image and affect their profitability (Kumar, 2009). The company may also consider being culturally sensitive in the country of operation. This requires an understanding of local culture, values, and customs. Developing and maintaining positive relationships with the local leaders is highly encouraged. By doing so, the companies obtain the support of the local community. Having the communities’ good will is essential especially in instances of social unrest. The company assets may not face the danger of being damaged since it has the support from the local community from where it is operating. Companies should utilize their experience with similar crises to their advantage. Since they are knowledgeably aware of how the markets were affected by those crises, they are in a better position to respond more appropriately than their competitors are (Adel Al Khattab, 2010). They should have adequate resources to ride out of the rough periods during a crisis. The resources include both finances and personnel. As indicated in Indonesia and Russia, the entry corporate governance of income taxes in these countries increased by 40 % due to stronger political environment (Adel Al Khattab, 2010). Additionally, companies operating in foreign countries should invest in information networks. As they operate in risky areas, the businesses should lay the groundwork for getting superior information. However, the reliability of these networks should be tested way before a political crisis occurs. The network should be well secured and any weak links eliminated as soon as they are identified. The companies should insure their businesses from political risks. They should focus more on comprehensive insurance covers that are inclusive of non-payment coverage. Political risk insurance is distinct from other insurance products available for multinational companies. Political events are those that can be clearly observable and measurable. This insurance is designed to protect the companies from political activities that may interrupt their operations, and facilitates investments in volatile environments. Coverage areas include non-honoring of a government’s commitment to an investor, war and civil disturbance, currency inconvertibility and breach of contract. The prices of these insurances depend on the level of political stability the country. Covers for businesses in high-risk countries are expensive compared to those in stable countries. The countries are reviewed at least once per year to determine and update their level of risk. However, companies must note that political risk insurance only protects firms against actions of non-payment. They do not provide coverage for all scenarios. Additionally, most of these insurance providers are experiencing credit supply issues and in turn reducing their credibility (Adel Al Khattab, 2010). Normally, the monthly premiums are very costly and may lead to additional expenditure by the company. On this note, political risks insurance should be the last resort in managing a company’s risks. Examples of insurance companies that offer such covers include Chubb and Lloyd’s of London. In their efforts to minimize the impacts associated with political risks, companies should integrate risk management strategies into the core values of the company. Most companies tend to pay little attention to risk political risk management. They should direct substantial amount of their resources to this section. If resources allow, they may employ full time risk managers. The managers should be responsible for identifying risks and taking the appropriate actions to guard the firm against them. By supporting those values with actions, the company will be in a position to foresee political risks and undertake appropriate measures. Characteristics of successful risk programs There are various characteristics associated with successful risk programs. The best programs are all-inclusive, that is, they are developed on the input and cooperation of every part of the organization. They are holistic as they consider how various risks can affect the companies’ stakeholders and operations. In addition, they are transparent and information and results are shared without discrimination with all the companies’ shareholders. Communication of risks is a central component of embedding political risk management into operating processes. Inadequate communication systems often prevent companies from using risk information effectively in operational decision-making. Finally, the best risk management programs have proactive systems and processes, which maximize the opportunities presented by political risks (Kumar, 2009). Despite the availability of beneficial risk management programs, most organizations face numerous challenges during the implementation process. These challenges include inadequate resources, namely, time, finances, and personnel (David, 2002). The company may lack the required resources for the successful implementation of these programs. At times, management may be unwilling to allocate resources towards political risks management programs. At times, the leadership may be adamant to embrace the culture of risk management. When this happens, risks improvement initiatives can be doomed from the outset (Kumar, 2009). When leaders refuse to support these initiatives, it becomes impossible for them to be implemented. This is because they are the same leaders who are responsible for allocation of resources across the organization. Conclusion Multinational companies are currently facing increased exposure to risks. It is true that risks exposes businesses to potential losses but, they also come with opportunities. Therefore, instead of trying to evade them, they should exploit these risks to their advantage and generate value. The most successful companies are associated with substantial risks, both economic and political risks. They seek risk, not avoiding it. Dealing with risks gives them an advantage over their adversaries. The importance of international business having political risk management programs cannot be overstated. In an increasingly politically insecure environment, businesses are striving to come up with the best mitigating processes to cushion them from political pressures and risks. Companies are increasingly becoming aware of the benefits associated with such programs, and are trying as much as they can to integrate these programs into their core values frameworks. They have realized that risk management issues require close attention to minimize the downside effects associated with political risks. Furthermore, companies should evaluate the amount and type of information they require for decision making during a crisis. After they know, what it is they require they can then invest in the appropriate hardware and software. This ensures timely and accurate delivery of information. The information flow should be quick and without distortion through the organization in all directions. References Adel Al Khattab, S., 2001. Informing Country Risk Assessment in International business. International Journal of Business and Management , pp.54-58. Baas, D., 2010. "Approaches and challenges to political risk assessment: The view from export development Canada." Risk management 12(2), pp. 135-162. Boulos, J., 2009. Assessing political risk. Texa: Brown Center. Bracken, J., and Ian, B., 2008. Managing Strategic Surprise: Lessons from Risk Management and Risk Assessment. Cambridge, UK: Cambridge UP. Brink, H., 2004. Measuring political risk: Risks to foreign investment. Aldershot, Hants: Ashgate. Clark, L., Adam D. and Ashby, M., 2009. Managing financial risks: From global to local. Oxford: Oxford UP. Click, W., 2005. "Financial and political risks in US Direct foreign investment." Journal of International business studies 36(5), pp.559-575. David, C., 2002., “Analyzing and Managing Country Risks,” Ivey Business Journal, 66(3), p.17. Desbordes, R., 2009. "Global and diplomatic political risks and foreign direct investment." Economics & Politics. Government in brief, 2011. Vietnam Net Bridge. 4 Dec. 2011. Available at: .Accessed on [4 December 2011] Harms, P., 2000. International investment, political risk, and growth. Boston: Kluwer Academic. Jensen, N., 2008. "Political risk, democratic institutions, and foreign direct investment." The Journal of Politics 70(4), p.1040. Henisz, W. and Zelner, B., 2010. ``The hidden risks in the emerging markets’’, Harvard business review, p.1-9 Khattab, A., John, A., and Eleanor, D., 2008. "Managerial practices of political risk assessment in Jordanian international business." Risk management 10(2), pp.135-152. Kumar, D., 2009. Marketing Research. London: Wiley. Rubins, N. and Stephan, K., 2005. International investment, political risk and dispute resolution: a practitioner's guide. Dobbs Ferry, NY: Oceana Publications. Sheeran, P. and Amber, S., 2004.. The international political economy of investment bubbles. Aldershot, Hants, England: Ashgate. World Bank, 2010. World Investment and Political Risk. Washington, DC: World Bank. Read More