Chapter 17
Foreign Direct Investment and Political Risk
◼ Learning Objectives
1. Demonstrate how key competitive advantages support a strategy to sustain direct foreign
investment
2. Explore the decision process of the multinational in its choices of markets and structural
choices for market entry
3. Define and classify the political risks faced by multinational firms when investing abroad
4. Examine the financial impacts of political risk on the multinational firm
5. Discuss the many different methods employed by multinationals to mitigate political
risks
◼ Chapter Outline
I. The Foreign Direct Investment Decision
A. Ownership Advantages
B. Location Advantages
C. Internationalization Advantages
D. The Financial Strategy
II. Structural Choices for Foreign Market Entry
A. Selecting Target Markets
The Behavioral Approach to FDI
MNEs in a Network Perspective
B. Choosing Entry Structures
Exporting Versus Production Abroad
Licensing and Management Contracts
Joint Venture Versus Wholly Owned Subsidiary
Greenfield Investments and Foreign Acquisitions
Strategic Alliances
III. Political Risk: Definition and Classification
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2. Market Imperfections. MNEs strive to take advantage of market imperfections in national
markets for products, factors of production, and financial assets. Large international firms
are better able to exploit such imperfections. What are their main competitive advantages?
3. Competitive Advantage. In deciding whether to invest abroad, management must first
determine whether the firm has a sustainable competitive advantage that enables it to
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4. Economies of Scale and Scope. Explain briefly how economies of scale and scope can be
developed in production, marketing, finance, research and development, transportation,
and purchasing.
5. Competitiveness of the Home Market. A strongly competitive home market can sharpen
a firm’s competitive advantage relative to firms located in less competitive markets.
Explain what is meant by the “competitive advantage of nations.”
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6. OLI Paradigm. The OLI Paradigm is an attempt to create an overall framework to explain
why MNEs choose FDI rather than serve foreign markets through alternative modes.
Explain what is meant by the “O,” the “L,” and the “I” of the paradigm.
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7. Financial Links to OLI. Financial strategies are directly related to the OLI Paradigm.
8. Where to Invest. The decision about where to invest abroad is influenced by behavioral
factors.
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9. Exporting Versus Producing Abroad. What are the advantages and disadvantages of
limiting a firm’s activities to exporting compared to producing abroad?
10. Licensing and Management Contracts Versus Producing Abroad. What are the
advantages and disadvantages of licensing and management contracts compared to
producing abroad?
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11. Joint Venture versus Wholly Owned Production Subsidiary. What are the advantages
and disadvantages of forming a joint venture to serve a foreign market compared to
serving that market with a wholly owned production subsidiary?
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12. Greenfield Investment Versus Acquisition. What are the advantages and disadvantages
of serving a foreign market through a greenfield foreign direct investment compared to an
acquisition of a local firm in the target market?
13. Cross-Border Strategic Alliance. The term “cross–border strategic alliance” conveys
different meanings to different observers. What are the meanings?
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14. Political Risk. How is political risk defined, and how does political risk associated with
business differ from a more general political risk to all social activities? What is the
difference between firm-specific risk and country-specific risk?
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15. Potential Financial Losses Political Risk. How do the major categories of potential
financial losses to multinational companies associated with political risk differ across
financial form—profitability, cash flow, and asset ownership?
16. Common Forms. Define the following types of political risk:
a. Adverse regulatory change
b. Breach of contract
c. Expropriation
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17. Lawful Expropriation. What criteria have to be met for a government’s seizure of a
company’s business to be considered “lawful” by international law?
The state, any state, has the sovereign right under international law to take property held
by private entities, domestic or foreign, through expropriation for economic, political, or
social reasons. (The taking of domestic property is referred to as eminent domain.) But in
order to be “lawful” under international law, the expropriation needs to meet four criteria:
18. Expropriation Distinctions. Answer the following:
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19. Lawful Compensation. Lawful expropriation must be accompanied by lawful
compensation. What criteria have to be met to fulfill this requirement?
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23. Investment Insurance. What is investment insurance, and what organizations provide
such coverage?
24. OPIC. Answer the following questions about OPIC:
a. What is OPIC? The U.S. investment insurance and guarantee program is managed by
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27. Blocked Funds. Explain the strategies used by an MNE to counter blocked funds.
What can a multinational firm do to transfer funds out of countries having exchange or
remittance restrictions? At least six popular strategies are used: