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CHAPTER 3
Legal, Technological,
Accounting, and Political Environments
Chapter Objectives
After studying this chapter, students should be able to:
2. Explain how domestic laws affect the ability of firms to conduct
international business.
4. Describe the impact of the host country’s technological environment on
international business.
6. Explain how firms can protect themselves from political risk.
LECTURE OUTLINE
OPENING CASE: When Is an iPhone Not an iPhone?
The opening case explores the importance of intellectual property and cultural
considerations when selling products in global markets.
Key Points
• Apple has had issues in attempting to protect intellectual property rights worldwide,
including a dispute with a Mexican telecommunications company, iFone.
• Apple has had similar problems in Brazil and China.
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CHAPTER SUMMARY
Chapter Three explores the legal, political, and technological environment within which
international businesses operate. The chapter begins with a discussion of the different
types of legal systems international companies may encounter. It then goes on to
discuss the way technological environments vary across countries. The final part of the
chapter addresses how firms deal with different regulations in different countries and
how they manage political risk.
THE LEGAL ENVIRONMENT
The Law and the Internet
Most existing laws predate the World Wide Web. Adjusting these laws to the needs of
the Internet is a difficult task. Activities sponsored by a Web site may be legal in one
country but not in another. This box discusses steps the U.S. and other countries have
taken to deal with some of these issues.
Differences in Legal Systems
Legal systems vary across countries for historical, cultural, political, and religious
reasons. Access to the legal system also varies from country to country. The basis of
different legal systems is discussed below.
• The United Kingdom and its former colonies all follow a legal system based on
common law. Common law is law based on the cumulative wisdom of judges’
decisions on individual cases through history. Thus, each country’s legal system
evolves as individual cases set precedents.
• Civil law is the world’s most common form of legal system. It is based on a detailed
listing, or codification, of what is and is not permissible. A main difference between
common law and civil law lies with the role of the judge. In the common law system,
the judge acts as a neutral referee, while in a civil law system, the judge takes on
many of the tasks that would be completed by lawyers in a common law system.
Domestically Oriented Laws
• Home country law clearly affects a firm’s domestic operations, but it may also affect
a firm’s international operations by regulating international business activities that
originate inside the country’s borders, affecting the ability of domestic firms to
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compete internationally, and affecting business activities that occur outside the
country’s borders.
VENTURING ABROAD
How Important is the Rule of Law?
A well-functioning legal system with clearly defined rules and procedures often
encourages foreign investment. Russia appears to be a country in which there is a
Laws Directly Affecting International Business Transactions
• A country may attempt to induce a second country to change an undesirable policy
by imposing sanctions – restraints against commerce with that country.
• In extreme cases, an embargo (a comprehensive sanction against all commerce
with a given country) may be imposed – such as India’s embargo on trade with Nepal
in the early 1990s.
Laws Directed Against Foreign Firms
• Nationalization occurs when a government takes possession of assets belonging to
a foreign company. When the government takes possession without compensating
the firms, it is called confiscation. When the host government compensates the
private owners for the assets, the transfer is called expropriation.
• Privatization is the conversion of state-owned property to privately owned property.
The Impacts of MNCs on Host Countries
• Economic and Political Impacts. The presence of MNCs affects the host country
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Dispute Resolution in International Business
• When resolving disputes in international business, four questions must be answered:
(1) which country’s laws apply? (2) in which country should the issue be resolved?
(3) which technique should be used to resolve the conflict—litigation, arbitration,
mediation, or negotiation? and (4) how will the settlement be enforced?
shopping.
• The principle of comity provides that a country will honor and enforce within its own
territory the judgments and decisions of foreign courts, with certain limitations. For
the principle to apply, reciprocity must be extended between the countries, proper
notice must be given to the defendant, and the foreign court judgment must not
violate domestic statutes or treaty obligations.
THE TECHNOLOGICAL ENVIRONMENT
• Countries change and shape their technological environment through investment.
Investments in infrastructure and human capital have allowed developed countries to
continue to prosper in world markets despite high wages paid to their workers.
• Technology transfer also affects the technological environment in host countries
around the world. MNCs bring new technologies with them when they start
operations in countries where they were not present before.
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THE ACCOUNTING ENVIRONMENT
Differences in national accounting philosophies and practices make it difficult for firms to
develop an accounting system that provides both the internal information required by
managers and the external information needed by shareholders.
The Roots of Differences
• A country’s accounting standards and practices reflect the influence of legal, cultural,
political, and economic factors. See Figure 3.1.
• In common law countries such as the U.S., accounting procedures typically evolve
from the decisions of independent standards-setting boards. However, in code law
countries such as France, accounting practices are determined by the law. The
Differences in Accounting Practices
• Several national accounting differences could affect international businesses. The
text notes that valuation and revaluation of assets, valuation of inventories, relations
with tax collectors, and use of accounting reserves are particularly important.
• Valuation and Revaluation of Assets. Because rules differ among countries as to
how a firm’s assets should be valued, firms are advised to exercise caution when
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BRINGING THE WORLD INTO FOCUS
The Sarbanes-Oxley Act
This section discusses Congress’ response to accounting scandals. Congress
passed the Public Company Accounting Reform and Investor Protection Act of 2002,
commonly known as the Sarbanes-Oxley Act. The act requires tighter internal and
external auditing controls. Complying with the act can be expensive for firms, and as
a consequence it appears that more foreign firms are choosing the London and
Luxembourg stock exchanges over the NYSE.
Impact on Capital Markets
• The differences in accounting practices can distort the measured performance of
THE POLITICAL ENVIRONMENT
Political Risk
• Political risk assessment is a systematic analysis of the political risks faced by
international businesses in foreign countries. Political risks include any changes in
the political environment that may adversely affect the value of the firm’s business
activities. Most political risks fall into one of three categories: ownership risk (where
• A macropolitical risk affects all firms in a country, while a micropolitical risk
affects only a specific firm or firms within a specific industry. The text provides
examples of each type of risk.
• Assessing political risk typically involves constant monitoring by the MNC. Some of
the best sources of information are the employees of the firm. In addition, embassy
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duration in the host country. Firms can then make a tradeoff between political risk
and the likely rate of return of a particular investment.
CHAPTER REVIEW
3-1 Describe the four different types of legal systems with which international businesses must
deal.
The four types of legal systems with which international businesses must deal are common
3-2 What is extraterritoriality?
3-3 How can an MNC affect its host country?
3-4 How do expropriation and confiscation differ?
3-5 Why do countries impose restrictions on foreign ownership of domestic firms?
3-6 How do restrictions on repatriation of profits affect MNCs?
In an effort to encourage local reinvestment of earnings, countries may limit the repatriation
of profits by MNCs. In some cases, the threat of restrictions on the repatriation of profits will
3-7 What factors influence the accounting procedures a country adopts?
3-8 How do German firms use accounting reserves?
3-9 What is the impact of differing accounting standards on the international capital market?
3-10 What is political risk? What forms can it take?
3-11 What is OPIC’s role in promoting international business activity?
OPIC’s role in promoting international business activity is centered around reducing the risk
QUESTIONS FOR DISCUSSION
3-12 What options do firms have when caught in conflicts between home country and host
country laws?
3-13 What is the impact of vigorous enforcement of intellectual property rights on the world
economy? Who gains and who loses from strict enforcement of these laws?
The protection of international property rights is the subject of ongoing debate between
countries and firms. Firms with patents, copyrights, trademarks, and/or brand names favor
strict enforcement of intellectual property rights on a global basis. If such protection is
3-14 Do you agree with the U.S. government’s policies restricting the export of dual–use goods?
Why or why not? (You may wish to check out the Bureau of Export Administration’s Web site,
which details how the bureau operates.)
The U.S. government restricts the export of dual-use goods on the grounds that they may be
used for military applications which could threaten the safety of the U.S. and its allies.
3-15 What is the impact on the global economy if governments fail to restore investor’s faith in
firms’ accounting records?
As investors look beyond their borders for profit opportunities, they must be able to have
confidence in the veracity of the information they receive concerning potential investment
3-16 What impact would harmonization of national accounting standards have on international
businesses?
Most students will probably agree that harmonization of national accounting standards
would be beneficial to most international businesses. Not only would such an action
3-17 Are U.S. firms at a competitive disadvantage because they can’t use accounting reserves
as German firms do?
Accounting reserves are often used by firms to adjust for foreseeable future expenses that
3.5; AACSB: Analytic Skills; Learning Outcome: Discuss trends in and the debate over
globalization)
BUILDING GLOBAL SKILLS
Essence of the exercise
This exercise is designed to provide students with experience in assessing political risk.
Students are asked to assess political and legal forces that might affect an investment in the
U.S.
Answers to the follow-up questions:
3-18 How easy or difficult was it to identify political or legal forces affecting your firm’s proposed
entry?
Students should find that it is relatively easy to identify macro forces affecting a proposed
investment, but more difficult to assess micro forces. In fact, since most students will
3-19 What other political or legal barriers might exist that you were unable to identify?
3-20 Are the potential barriers so great as to keep your firm out altogether? Why or why not?
3-21 Do different levels of government (city, state, and federal) pose different political and legal
barriers to your firm? If so, describe these differences.
The response to this question will, of course, depend on the type and location of investment.
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Other Applications
Students completing this exercise will be examining investment in the U.S., a country that
has a relatively open attitude toward investment. To provide students with a more
CLOSING CASE
Tiny Islands, Big Trouble
The closing case examines the political and geographical disputes over three small island
chains in the South China Sea. Although the land spread is small, the economic, strategic, and
political importance is significant. Brunei, China, Japan, Malaysia, Taiwan, the Philippines and
Vietnam have each staked a claim on part or all of these areas.
Key Points:
• Squabbling over three small island chains—the Spratly Islands, the Paracel Islands,
and the Pinnacle Islands—and two submerged shoals and reefs—the Macclesfield
Bank and the Scarborough Shoal—threaten to undermine trade relations and
escalate political conflicts among Brunei, China, Japan, Malaysia, Taiwan, the
Philippines, and Vietnam, which have staked claims to part or all of these areas.
Case Questions
3-22 Pick one of the island chains (Paracel, Spratly, Pinnacle/Senkaku/Diaoyu/Tiaoyutai)
under dispute. Research the claims of the parties asserting ownership of the island chain.
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Prepare a short memo summarizing the ownership claims, the basis of those claims, and a
possible solution to the dispute. Are bilateral negotiations, arbitration under UNCLOS, or a
region-wide code of conduct the best way to resolve the conflicts? What are the advantages
and disadvantages of each approach?
Answers may vary with respect to the ownership claims. Bilateral negotiations
provide the opportunity for a direct and focused resolution between parties for a
3-23 Suppose you are an executive for Forum Energy PLC, which was granted exploration
rights in the Spratlys by the Philippines. What political risks do you face? What can you do
lessen these political risks?
Political risks are derived from the competing claims from other nations and
3-24 Suppose you are an executive for Toyota, which has extensive FDI in China and has
targeted the Chinese market as critical to the company’s future growth. What political risks
to you face? What can you do to lessen these political risks?
Toyota has political and military risk derived from long-standing political differences
and military disputes between Japan and China. Toyota also has the risk of
Additional Case Application
Students can be asked to contemplate a major investment in a country that is undergoing
tough economic times. Students should conduct a political risk assessment of this
investment. Students may take various approaches to this exercise depending on the
