Chapter 10 – Managing Political Risk, Government Relations, and Alliances
Chapter 10: Managing Political Risk, Government
Relations, and Alliances
Learning Objectives and Chapter Summary
1. EXAMINE how MNCs evaluate political risk.
Political risk is the likelihood that the foreign investment of a business will be
constrained by a host government’s policies. In dealing with this risk, companies
conduct both macro and micro political risk analyses. Specific consideration is
2. PRESENT some common methods used for managing and reducing political risk.
MNCs attempt to manage their political risk in two basic ways. One is by
developing a comprehensive framework for identifying and describing these risks.
3. DISCUSS strategies to mitigate political risk and develop productive relations with
governments.
4. DESCRIBE challenges to and strategies for effectively manage alliances.
Effective alliance management includes careful selection of partners, defining the
10-1
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
The World of International Management: Shell’s Russian Roulette
1. Summary: In 2006 Royal Dutch Shell owned a majority stake in the Sakhalin0II
energy project, the largest oil and gas project in the world. However, Russian took
(at very discounted prices) half of that share for its Russian-based Gazprom, despite
the fact that the country had depended on the foreign investment to get its
production infrastructure up and running. The agreements in the 1990s had been
fair and profitable for both sides until cost overruns soured the government. Shell
was forced to choose between withdrawing from Russia or accepting its new
demands; Shell stayed. BP faced similar problems: disagreements over strategy,
visa problems, criminal investigation of the CEO, stalled talks. BP eventually
“sold” its 50 percent stake in TNK-BP.
The World Bank in 2013 ranked Russia 178th out of 185 on dealing with
construction permits. Corruption, red tape, security concerns, and overall lack of
faith in governmental policies result in an especially difficult political environment.
Today the business environment is a deterrent for growth.
2. Suggested Class Discussion:
1. What made Russia such an attractive opportunity for Shell? What changed?
2. How have Russia policies affected foreign oil companies in the country? Do you
think the companies brought their problem on themselves? Why or why not?
3. How can a political risk assessment help international managers quantify the
risk in a particular country prior to making an investment?
3. Related Internet Sites:
BusinessWeek: {http://www.businessweek.com}.
Shell: {http://www.shell.com/}.
BP: {http://www.bp.com/}.
The World Bank: {http://www.worldbank.org/}.
10-2
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
Chapter Outline with Lecture Notes and Teaching Tips
The Nature and Analysis of Political Risk
1) The unanticipated likelihood that a foreign investment will be constrained by a host
government’s policies is known as political risk. Political risk is especially evident in
2) Examples of risk factors: freezing the movement of assets out of the host country, placing
limits on the remittance of profits or capital, devaluing the currency, appropriating assets,
and refusing to abide by the contractual terms of agreements previously signed with the
MNC
3) China’s recent moves: price controls, currency restrictions, limits on sale of state-owned
companies—may reflect economic slowdown, but will make it more difficult to move
money in and out of the country. Counterfeit goods made in China are a major problem for
U.S. businesses. The government restricts Internet content, as Google experienced.
Chinese MNCs must also assess the political risk inherent in doing business in the United
States. U.S. wants markets opened to its trade goods. Other problems: China’s
unwillingness to revalue the yuan, safety problems with pet food, toys, dry-wall produced
there.
Macro and Micro Analysis of Political Risk
1) An analysis that reviews major political decisions likely to affect all enterprises in the
2) An analysis directed toward government policies and actions that influence selected
3) Macro Risk Issues and Examples: In recent years macro risk analysis has become of
increasing concern to MNCs because of the growing number of countries that are finding
their economies in trouble, as in Southeast Asia, or even worse, unable to make the
transition to a market-driven economy like Russia.
a) Risks: Freezing the movement of assets out of the host country, placing limits on the
remittance of profits or capital, devaluing the currency, appropriating assets, refusing
layered bureaucracy).
d) At this time as well, many MNCs are reluctant to invest very heavily in most Middle
Eastern countries.
10-3
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
e) Central, if not Eastern, Europe is more appealing, but still has problems.
f) Some Latin American countries have effectively forced divestment by MNCs.
g) Government corruption is a significant concern for many companies (Indonesia, for
example). Table 10–1 provides a ranking of countries in terms of corruption levels.
The United is 19th.
4) Micro Risk Issues and Examples: Micro risk issues often take such forms as industry
regulation, taxes on specific types of business activity, and various restrictive local laws.
a) The essence of these micro risk issues is that some MNCs are treated differently from
others.
b) In 1992 American steel makers charged that foreign steel makers were dumping their
products in the U.S. market at artificially low prices. American steel makers insisted
that their government force foreign producers to raise their prices. Tariffs were
imposed, then rescinded, an example of micro political risks in the U.S.
c) The WTO ruled that the United States’ 1916 Anti-Dumping Act violates global trade
regulations and cannot be used by American firms to fend off imports.
d) As a result of a decision by the European Commission, Microsoft must share technical
information with rivals that will help their server software work better with Windows.
Such regulatory actions are good examples of micro risk issues that MNCs face from
industry regulation.
e) Table 10–2 provides a guide that MNCs can use to evaluate political risk.
f) In some instances, it is not clear whether macro or micro political risk is at work.
Teaching Tip: Campbell R. Harvey, Fuqua School of Business, and Duke University
maintains an Internet site that contains international business material. The site includes a
table for A Comparison of Country Risk Providers and Graphs of Political Risk,
Economic Risk and Financial Risk for 117 Countries, which presents information on the
risks of doing business in particular countries. The site, which is very extensive and well
done, is available at {http://www.duke.edu/~charvey/Country_risk/couindex.htm}.
Terrorism and Overseas Expansion
1) Terrorism has existed for centuries, but has become more of a concern over the last few
years, especially in the United States in light of the September 11, 2001 attacks.
a) Terrorism is the use of force or violence against others to promote political or social
views.
b) Three types of terrorism exist:
i) Classic: a specific, well-defined objective pursued by well-trained, professional,
extremely passionate
10-4
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
c) MNCs need to be wary of the combative political environment that may exist when
they seek to engage in overseas expansion in certain geographic areas. Terrorism
within a country can have a significant impact on the MNC in the macro sense.
Analyzing the Expropriation Risk
1) Expropriation refers to the seizure of businesses by a host country with little, if any,
compensation to the owners.
a) At greatest risk are in extractive, agricultural, or infrastructural industries such as
utilities and transportation, because of their importance to the country.
b) Large firms often are more likely targets than small firms, because more is to be
gained by expropriating large firms.
2) Indigenization laws are laws that require that nations hold a majority interest in the
operation.
Teaching Tip: The Library of Congress Country Studies is a series of in-depth studies, in
booklet form, of the different countries of the world. Each country study, which is
available online at no charge, provides an assessment of the business environment and the
political risk in a particular country. There are currently over a hundred country studies
available at {http://lcweb2.loc.gov/frd/cs/cshome.html}.
Teaching Tip: The Economist Weekly {http://www.economist.com/} is an international
magazine that provides excellent coverage of worldwide political and economic issues.
The magazine’s Internet site presents a limited selection of articles from the current issue.
Managing Political Risk and Government Relations
1) MNCs often develop a comprehensive framework that identifies various risks and assigns
a quantitative risk or rating factor to them in an effort to manage political risk.
Developing a Comprehensive Framework
1) A comprehensive framework for managing political risk should consider all political risks
and identify those that are most important. Schmidt has offered a three-dimensional
framework that combines political risks, general investments, and special investments.
Figure 10–1 illustrates this framework.
2) Political Risks: Three basic categories:
a) Transfer risks stem from government policies that limit the transfer of capital,
10-5
3) General Nature of Investment: The general nature of investment examines whether the
company is making a conglomerate, vertical, or horizontal investment.
a) A conglomerate investment is a type of high-risk investment in which goods or
c) A horizontal investment is an investment in foreign operations to produce the same
goods or services as those produced at home; not likely to be takeover targets.
4) Special Nature of Investment: The special nature of foreign direct investment relates to
the sector of economic activity, technological sophistication, and pattern of ownership.
a) There are three sectors of economic activity:
i) The primary sector: agriculture, forestry, and mineral exploration and extraction
ii) The risk factor is assigned based on sector, technology, and ownership.
5) Quantifying the Variables in Managing Political Risk: Some MNCs attempt to manage
political risk through a quantification process in which a range of variables are
simultaneously analyzed to derive an overall rating of the degree of political risk in a
given jurisdiction. This comparison allows them to identify how risky a venture is in one
country versus another.
b) See Table 10–3 for an example of criteria for qualifying political risk.
Techniques for Responding to Political Risk
1) Once the political risk has been analyzed by either the framework or quantitative analysis,
2) Relative Bargaining Power Analysis:
a) According to this theory, the MNC works to maintain a bargaining power position
3) Integrative, Protective, and Defensive Techniques:
a) Integrative techniques are techniques that help the overseas operation become a part of
the host country’s infrastructure. These include:
i) Developing good relations with the host government and other local political
groups
10-6
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
ii) Producing as much of the product locally as possible with the use of in-country
suppliers and subcontractors, thus making it a “domestic” product
iii) Creating joint ventures and hiring local people to manage and run the operation
iv) Doing as much local research and development as possible
v) Developing effective labor-management relations
b) Protective and defensive techniques are techniques that discourage the host
government from interfering in operations.
i) Examples:
Doing as little local manufacturing as possible and conducting all research and
development outside the country
Limiting the responsibility of local personnel and hiring only those who are
iii) Developing countries do not hold advanced management skills in as high regard as
developed countries; thus a mixed strategy.
iv) Industries that utilize little technology exhibit the strongest integrative technique
while still employing a defensive strategy.
Teaching Tip: An excellent review of business regulations in a number of different
countries is provided by the International Trade Center―UNCTAD/WTO at
{http://www.intracen.org/}.
4) Proactive Political Strategies: Because government policies can have a significant
impact on business activities, and many governments face competing pressures from a
range of stakeholders, MNCs must adopt various proactive strategies to both affect
government policy and to respond to competitor efforts to influence that policy.
a) Broadly, strategies may include leveraging bilateral, regional, and international trade
and investment agreements, drawing on bilateral and multilateral financial support,
and using project finance structures to separate project exposure from overall firm
risk.
b) They also can include entering markets early in the privatization-liberalization cycle,
establishing a local presence and partnering with local firms, and pursuing pre-
emptive stakeholder management strategies to secure relationships with all relevant
actors.
c) Proactive political strategies include formal lobbying, campaign financing, seeking
advocacy through embassies and consulates of the home country, and more formal
public relations and public affairs activities such as grassroots campaigning and
advertising.
d) Developing and maintaining ongoing relationships with political actors, including
officials in power and in opposition parties, and with the range of stakeholders,
including nongovernmental organizations (NGOs) and others, can help buffer host-
government actions that may constrain or undermine MNC strategies and plans.
10-7
Chapter 10 – Managing Political Risk, Government Relations, and Alliances
e) No one strategy is guaranteed to work, but building a relationship with all parties
involved could assist in the betterment of any method an MNC employs.
Managing Alliances
1) Some partners may be current or former state-owned enterprises; others may be controlled
or influenced by government agencies.
2) MNCs must manage the relationships inherent in their alliances with other organizations
including current or former state-owned enterprises.
The Alliance Challenge
1) International strategic alliances (ISAs): Primary factors motivating firms to enter into such
relationships include faster entry and payback, economies of scale and rationalization,
complementary technologies and patents, and co-opting or blocking competition.
2) How an alliance relationship is developed is largely a function of interfirm negotiation. A
fundamental challenge of alliances is managing operations with partners from different
national cultures, especially along the dimensions of uncertainty avoidance and long-term
orientation.
3) Alliances include both value-claiming activities (competitive, distributive negotiation) and
value-creating activities (collaborative, integrative negotiation).
4) Challenges:
a) Managing operations with partners from different national cultures
b) Preparation for alliance termination: a number of legal and business issues need to be
addressed in advance.
The Role of Host Governments in Alliances
1) Many host governments require investors to share ownership of their subsidiaries with
local partners. These mandates can include specific requirements.
2) Host governments have a substantial role in the terms under which alliances are initially
formed, the way in which they are managed, and even the terms of their dissolution.
Examples of Challenges and Opportunities in Alliance Management
1) Alliances and joint ventures are increasingly common modes of entry and operation in
international business.
a) A good example is provided by Ford Motor and Mazda.
10-8