Political sources of international business risk: an interdisciplinary framework.

van Wyk, Jay

INTRODUCTION

Chavez is elected president of oil-rich Venezuela, HIV/AIDS infection rates rise in South Africa, a caricature of Mohammed appears in a Danish newspaper cartoon: all examples of relatively isolated events within the human experience, which overtime, became politicized and resulted in significant International Business risks for firms. Outcomes included nationalization of assets, escalation of production costs and decline in productivity, and a devastating consumer boycott. However, these events did not occur within a vacuum. There was a perceptible evolution of issues, which if identified and tracked, would have provided an astute manager with risk management options to mitigate or, even, to defuse negative impact. The inability of managers to foresee these developments is largely due to a fragmented, rather than integrated, approach to risk identification and risk management.

International Business as a field of inquiry is essentially interdisciplinary by nature. Explanatory theories and insights are drawn from diverse disciplines such as economics, finance, management, strategy, philosophy, political science and other social sciences. (Buckley and Lessard, 2005; Shenkar, 2004) However, the study of risk, especially political risk, in International Business suffers from a deficit in interdisciplinary analysis. Too often, risk analysis is compartmentalized into distinctive risk types associated with specific disciplines such as political risk, macroeconomic risk, legal liabilities, social risk and financial risk. (Miller, 1992; Miller and Waller, 2003; Van Wyk, Dahmer and Custy, 2004; Eiterman, 2001; Van Wyk and Baerwaldt, 2005)

The challenge by Brewer (1983) remains valid in that the political context of international business risk is still poorly understood by business managers. A useful approach may be to explore the political sources of international business risk that will by-pass the above limitations of risk analysis. Earlier studies refer to sources of risk. Simon (1984) argued that the sources of risk may originate in political events that occur in the institutions of host countries, home countries and the international environment. Such events may directly or indirectly have an adverse impact on the operations of a firm. Robock (1971) outlined a conceptual framework consisting of sources of political risk, actors who generate political events, and the affects of political risk on firms. Sethi and Luther (1986) identified political, economic and social-cultural sources of political risk in both home and host countries. Howell and Chaddick (1994) insightfully defined political risk as "the possibility that political decisions, events or conditions in a country will affect the business environment such that investors will lose money or will have a reduced profit margin." Risk raters, such as Business Environmental Risk Intelligence SA, do refer to symptoms and causes of risk as well as government policies that create risk exposure. However, such ratings are more concerned with imposing rigid quantitative metrics on illusive social phenomena and arriving at aggregated risk scores than with tracking the emergence and growth of risk. The guidelines of these authors necessitate a more comprehensive analysis of the political context from which business risks emerge.

In an effort to augment an interdisciplinary approach to the study of risk, this paper will combine a political system approach drawn from the field of political science with the sequential flow of risk in management studies in order to track the emergence and growth of risks for firms operating in the international environment. Accordingly, this paper will be organized into three parts: discussing the political system framework of analysis relevant to the comparative study of politics in any society, linking the sequential flow of risk to the functions of the political system, and proposing proactive and remedial risk management policies to deal with risk formation.

THE POLITICAL SYSTEM FRAMEWORK OF ANALYSIS

The concept of political system refers to the political activities and processes of a society. The political system is a functional macro view of a polity and is less constrained by the legal and institutional limitations of related concepts such as state, nation or government. (Andrian, 1994; Wiseman, 1966) Common to most definitions of the political system is its association with the use of legitimate coercion in society. Easton (1953) speaks of the authoritative allocation of values; and Dahl (1963) of power, rule and authority. This implies that the political system has legitimate sanction: the rightful power to enforce, to compel or even to punish. Although coercion is the distinctive quality of the political system, it will not solely rely on force or compulsion to set rules of society. In political systems, with high levels of legitimacy, the government will rule with the consent of the ruled.

Almond and Powell (1966) distinguish three levels on which the political system functions. (See Fig. 1) The first function is internal to the system: conversion processes occur when inputs are transformed into outputs. Easton (1965) distinguishes two classes of inputs into the political system, namely demands and supports. Demand inputs may be for goods and services (e.g., health care), regulation of behavior (e.g., product safety), participation (e.g., to petition government policy), and symbolic inputs (e.g., display of the political systems' commitment to values such democracy, market capitalism). Support inputs are essential resources needed to convert demand inputs into outputs.

Support inputs include material support (e.g., allocation of public funds), participation (e.g., political activism such as joining organizations, communication about politics), and obedience to laws and regulations. The sources of inputs may come from political elites inside the political system, from boundary-crossing activities of societal organizations (e.g., NGOs, firms) or from the international community (e.g., international organizations, foreign governments, MNEs, IGOs). From the perspective of international business, inputs may originate in the host or home country of an international firm.

[FIGURE 1 OMITTED]

In every political system, there is a set of political structures or institutions which initiates and processes inputs and converts them into outputs. (Almond, 1965) The demands entering the political system are articulated; aggregated or combined; converted into policies, rules and regulations; and applied, enforced and adjudicated. The articulation of interests or demands is performed by NGOs and lobbies. Interest aggregation is the function of political parties. The conversion of policy proposals into authoritative or binding rules is the function of government rule-makers (e.g., legislatures, executives). The application of general rules to particular cases is the function of the government's bureaucratic agencies. The adjudication of rules in individual cases is the task of the judiciary. Through the process of political communication, information about inputs and outputs are disseminated throughout the political system.

The second level of functioning involves the political system as a whole interacting with its environment. The boundary between the political system and its environment is flexible and may expand or contract as levels of political participation shift. As this level, performance and capabilities may be judged based on the outputs of the political system. Lasswell (1936) depicts it as "who gets what, when and how". Parsons (1960) describes capabilities as the mobilization of societal resources and their commitment for the obtainment of collective goods, and for the formulation and implementation of public policy. Almond and Powell (1966) distinguish among five categories of system capabilities or outputs: extractive, regulative, distributive, symbolic and responsive. The extractive capability refers to the political system's ability in drawing material and human resources from the domestic and international environment (e.g., taxes). The regulative capability refers to control over individual or organizational activities. The distributive capability refers to the allocation of goods, services, honors and opportunities to individuals, groups or organizations within society. The symbolic capability indicates the ability of the political system to affirm the values of society and elites. The responsive capability is a measure of the political system's success in converting legitimate demands into appropriate policies.

The third function of the political system entails maintenance and adaptation. In a political system, the incumbents of various roles (e.g., legislator, judge, bureaucrat) must be recruited to these roles and socialized to perform them. In democracies, elections are the primary recruitment function to fill the important decision-making roles in the political system. In nondemocratic systems, more opaque recruitment methods are employed (e.g., appointment, cooptation, rigged elections). Political socialization is the process of induction into the political culture of a society. Agents of socialization include families, schools, work places, religious organizations and identity groups. System maintenance and adaptation are embedded in a political culture of a society. Political culture consists of attitudes, beliefs, values and emotional feelings toward the political system. (Kim, 1964). Political culture may capture notions of political and economic ideologies regarding the desired nature of government and the economy. In plural or divided societies, there may be competing political cultures which may be a source of fragmentation and conflict. Almond and Verba (1963) distinguish among three broad types of culture: parochial, subject and participant. In parochial systems, individuals manifest marginal awareness or participation in national political life. Other identifications (e.g., ethnicity, regionalism, religion) may supersede a sense of national identity or dictate the functioning of the political system. In subject political cultures, individuals have awareness of the political system and the impact which its outputs have upon their lives, but they are not oriented or are restricted to participate in meaningful input demands. In participant political cultures, individuals and organizations are oriented to the inputs structures and processes of the political system. They engage or view themselves as potentially engaging in the articulation of demands and the making of decisions.

Disfunctionality may affect the functioning of the political system and its ability to address input demands. Rule-makers may react in different ways to disfunctionality: adapt their behavior and acquiesce to such demands; reject demands; display indifference or even deny the seriousness of demands; or react in a substitutive manner (e.g., outputs are directed at more pressing demands). (Almond, 1965) The literature of agenda building pays particular attention to such disfunctionality. (Cobb, Ross and Ross, 1976; Cobb and Elder, 1971; Grindle and Thomas, 1991; Jones, 2001) A distinction may be made between a public agenda and formal agenda. A public agenda entails issues which have achieved a high level of public interest and visibility. A formal agenda is a list of issues which decision-makers have formally accepted for serious consideration. Agendas manifest in three patterns: outside initiatives, mobilization and inside access. The outside initiative pattern involves demands by interest groups and political parties outside the formal governmental structures. For such groups, to move demands from the public to the formal agenda requires crossing major obstacles: formulating grievances into specific demands; expanding their support base to other influential groups and the general public; and in doing so, attracting serious attention from decision-makers. In the mobilizing pattern, demands are initiated by political elites, but interest groups and the general public are mobilized to shift the issue from the public to the formal agenda. In the inside access pattern, decision-makers initiate demands. Due to the power of such elites, expansion to the public agenda is not required and the issue automatically ends up on the formal agenda. In democracies, all three patterns of agenda setting are normally available. In nondemocratic systems, agenda setting is dominated by inside initiatives and mobilization. In systems that lack regime legitimacy, outside initiatives, particularly by opposition groups to move demands from the public to the formal agenda, also encounter serious impediments.

THE SEQUENTIAL PROCESS OF RISK FORMATION

The notion that risk is the result of a sequential process is well established in various management literature streams. Business continuity planning, according to Zsidisin, Ragatz and Melnyk (2005), focuses on multiple drivers of threats and vulnerabilities; the impact of such threats in the form of risk exposure of the firm; and managerial policies to mitigate risk, e.g., awareness creation, prevention, remediation and knowledge management. In scenario planning, the sequential development of risk is plotted. By combining factual data, experience and creativity, managers may identify the emergence of risk and the opportunities within scenarios, and explore possible future alternatives of risk management. (Schoemaker, 1991; Schoemaker, 1993) Miller and Waller (2003), by combining scenario planning with real options, argued that such an approach may assist managers in identifying, categorizing and tracking uncertainties and risk through the scanning of a continuum of environmental contingencies. Howell (2002) identified three steps in risk formation: resources, events and losses. The sources have some similarity to other societal systems embedded in the environment of the political system. (See Fig. 3) Howell's notion of events lacks nuance of the input and conversion processes of the political system. His notion of losses may be compared with outputs of the political system. (See Fig. 1)

The sequential flow of risk is closely linked to the various processes and functions of the political system. (See Fig. 1)

[FIGURE 2 OMITTED]

The sequential process is a form of risk mapping which provides a framework to track the origins and growth of risk producing activities. This sequential flow is an unfolding process that may be perceived as moving from conditions to politicized events to threats and, finally, to risk. The formation of risk occurs over time which may provide a window of opportunity for managers to develop viable and timely policy responses to the formation process before it actually results in a business risk.

CONDITIONS FOR RISK FORMATION

Risks typically emerge from conditions which brew primarily inside the political system or its embedded context (e.g., environments, systems). Simon (1984) indicated that the flow of the political sources of risk may originate in domestic or external environments or systems. The flow may follow a direct or indirect sequential path until it adversely impacts on the profitability of a firm or industry. However, such flows may be more multifaceted than a mere one or two step process due to the globalized nature of international business, the internationalization of domestic politics, and the transnational activity of organizations such as firms, NGOs, IGOs and governments. McAdam (1998) refers to a multilevel game involving MNEs, states, NGOs, and the transnational protest movement.

[FIGURE 3 OMITTED]

Relevant issues emerging from the above conditions may eventually appear on the public agenda or even the formal agenda. By way of illustration, activism against globalization and global warming grew from low key, under-the-radar protests to a full scale transnational movement that succeeded in placing these issues on the formal agenda of many governments. According to O'Neill (2004), the transnational protest movement is composed of wide ranging and diverse groups such as domestic interest groups (e.g., farmers, landless workers, indigenous peoples, labor unions) and professional transnational NGOs. These groups use a variety of mechanisms (e.g., street protests, litigation, lobbying, mass media socialization) to oppose the forces of global capitalism propounded by MNEs, IGOs, and governments; to influence and to shape debates and agendas early in "issue lifecycles"; and to promote alternatives to market capitalism and the state system. According to Doh and Teegen (2003), NGOs may act as stake-givers or stake-takers in their relationships to firms. Stake-givers provide prestige, legitimacy and the aura of neutrality and moral authority to firms' strategy in areas as diverse as human rights, ethics and corporate social responsibility. However, NGOs acting as stake-takers may damage the reputational and profit base of corporations. NGOs, both in host or home countries or acting transnationally, are formidable forces that impinge upon, attack, alter, amplify or distort the once bargaining relationship between businesses and governments.

POLITICIZED EVENTS

The second stage of the development of risks moves from the perceptual or dispositional to the behavioral level, i.e., conditions are transformed into events. This may be regarded as the politicization of an issue by a political structure such as an interest group, NGO, political party, parliamentary faction or bureaucratic agency. In this stage, demands are made on the political system and support resources are sought in an effort to convert an input into an output. The event or behavioral phase may occur due to boundary-crossing inputs or "withinputs" which occur inside the political system. A boundary-crossing activity may involve an interest group (e.g., trade association, labor union) that crosses the boundary of the political system by demanding that the government introduce protectionist regulations to save jobs in the face of strong competition from international firms. (Kobrin, 1979) Another example of boundary-crossing activity is that political groups in the home country of a firm may demand that such a firm divest from its business operations in its host country with an unsavory human rights record. Actions may include protest marches, consumer boycotts and even legal action. This form of interest aggregation may also gather support from sympathetic NGOs operating in the international or global environments.

"Withinputs" refer to demands that originate within the political system, usually driven by powerful elites, institutional interest groups in the legislature or bureaucracy, or even by judicial activism of the courts. Such organizations often have inside access to agenda setting, and as incumbents of powerful positions, may dominate the formal agenda setting process. Easton's (1965) notion of politicized events, such as change in political authority or regime, may heighten risk exposure. For example, a new government (political authority) committed to increase protectionism will increase the risk perception of current or potential foreign investors. By the same token, a new government committed to increased trade liberalization will lessen risk perceptions among foreign firms. Change of political authorities but maintenance of regime may not increase risk perceptions.

For example, Italy had 18 changes of government (political authorities) between 1970 and 1995, but that had little impact on business risk because the country's regime (rules of the game) remained intact. The Italian political system displayed high legitimacy despite constant change. (Maher, 2005) In contrast, changes in political authorities may also result in regime changes. The Chavez government in Venezuela after its electoral victory in 1998 also changed the regime by adopting a new constitution. This change did not alleviate regime illegitimacy, but instead led to increased political instability including mass labor strikes, public protests and an attempted coup. (Shifter, 2006; Whalen, 2006)

THREATS

The third stage of risk development occurs when the actions of political organizations pose a threat to the operations, opportunities or interests of an international firm. At this stage, politically based threats may expose a sense of uncertainty among businesses. The term uncertainty, as used in strategic management and organizational theory, refers to the affect of unpredictability of environmental or organizational variables that negatively impact on corporate performance. It may also refer to the inadequacy of information about these conditions. (Miles and Snow, 1978) According to North (1990), uncertainty is a condition wherein one cannot ascertain the probability of an event and therefore cannot arrive at a way of insuring against such an occurrence. Risk, on the other hand, implies the ability to make an actuarial determination of the likelihood of an event and hence insure against such an outcome. Kobrin (1979) distinguished between certainty, objective uncertainty and subjective uncertainty. Certainty occurs if a single outcome may be unambiguously associated with a given event. Objective uncertainty may be approximated by situations where, while one outcome does not dominate, all feasible outcomes are known, information is readily available and almost all observers agree upon probabilities. Subjective uncertainty means opinions about the relative likelihood of events are based upon perceptions that are a function of the available information, previous experience, and individual cognitive processes which synthesize all into an imagined future.

A threat may be viewed as an expression of intention by a political organization to inflict damage or harm on a business firm. A threat may be motivated as retribution or punishment for something a firm did or left undone (e.g., sweatshop conditions in the workplace, harmful products). A threat may also be an expression of intention to restrict the profitability of a targeted firm or industry due to value changes (e.g., ideology) which have occurred in the political system. Table 1 outlines the nature of business threats as related to the functions of the political system.

In this stage of the conversion process of the political system, there will be many early warning signals that political organizations have harmful intentions towards companies or industries. Indicators of the probability of future risk may include public statements of intent by political elites (e.g., speeches), threats of industrial action (e.g., strikes, messages, website blogs), media reports on the probability of harmful action, and, most significantly, the introduction of legislation to inhibit business operations. Following the suggestions of Almond and Powell (1966), changes in the style of interest articulation, interest aggregation or rule functions in the political system may indicate that politicized events have degenerated into threats. Such changes may indicate that issues have become part of the public agenda or, even more threatening, have moved to the formal agenda. Markers include

1. A change from latent to manifest behavior: mood clues. i.e., vague grumblings change to explicit demands for action

2. A change from diffused to specific behavior: dissatisfaction with specific means of correction (e.g., "MNEs are bad"), changes to specific requests for legislation (e.g., limits on foreign ownership of national mineral resources)

3. A change from general to particular behavior: general demands couched in class or associational group terms (e.g., reform large estates), change to particular demands entailing specific action (e.g., nationalize large estates)

4. A change from affective to instrumental behavior: affective behavior in the form of a verbal expression (e.g., anger, disappointment, hope) of an interest group may change into instrumental demand such as a threat of support withdrawal (e.g., finance, vote) contingent on a particular action (e.g., acceptance of legislation or policy)

Scenario planners that routinely scan the environment for early warning signals epitomize the benchmark for threat recognition. In SWOT analysis, weakness and threat are similar to the manner in which threat is used here. In general, threats (demands) backed by appropriate support (e.g., government power) should be regarded as credible threats.

RISK

The critical component that changes a threat into a risk is that risks become actions by political organizations which will adversely impact on a foreign firm's profitability. These risks may occur due to the outputs of the political system (e.g., government intervention in the business environment) or disruptive and destructive actions occurring during the conversion process of the political system (e.g., internal conflict). Business risk occurs when a firm's profitability is adversely affected by politics. A firm's profit should not be viewed in isolation, but relative to the activity or investment required to generate such profits. Profitability is a measure of a firm's overall performance on a relative basis of relating various measures of profit to either sales or investment. (Lewellen, Halloran and Lanser, 2000) Risk exposure, therefore, means variability in profitability that falls short of expected returns such as ROI and ROA. (Butler and Joaquin, 1998; Click, 2005)

In this analysis, international business risk is regarded as similar to strategic risk. (Slywotzky, 2004) From a strategic perspective, Simons' (2000) classification of risk types offers utility to study risk in a functional manner, rather than the discipline-bound classifications of risk mentioned above. Simons distinguishes between four types of risk: operations risk, asset impairment risk, competitive risk, and franchise and reputational risk. Operations risk stems from the unanticipated costs of system downtime and unexpected variants of production downtime. In general business terms, operations risks are caused by disruptions of a firm's value creation activities, emanating from the activities of political organizations. Asset impairment risk refers to a significant loss in the current value of an asset or resource owned by a company, including financial and physical impairment and piracy of intellectual property rights (e.g., patents, brand names). Competitive risk refers to changes in regulations which restrict a firm's competitive advantage and opportunities in host markets. Franchise risks refer to legal liabilities (e.g., pending lawsuits, legal actions) and reputational risks occur when the value proposition of a firm (e.g., products, brand name, corporate image) are viewed unfavorably by stakeholders such as customers, suppliers, governments, NGOs, and the mass media.

In Table 2, Simons' four types of risk are correlated with the broad functions of the political system. Risk emanating from the conversion process is largely related to political instability. In a political system facing a legitimacy crisis or operating in a fragmented political culture, ensuing input frustrations may not only result in violence, but firms may become targets of civil strife.

By itself, responsive and symbolic outputs do not constitute business risk, but in conjunction with more intrusive outputs (e.g., regulation, extraction, distribution), they add the perceptual or cognitive climate of harmful intent. The examples in Table 2 are obviously not exhaustive, but the matrix provides a framework for wider application, i.e., in a particular country, industry or value creation process (e.g., supply chain management).

MANAGERIAL IMPLICATIONS

Understanding the functioning of political systems, and the related sequential process of risk formation, may assist firms in developing and executing appropriate risk management policies. Table 3 summarizes a number of policy options available to mitigate risk at various stages of the risk formation process. (Hilbert and Jones, 2004; Lhabitant and Tinguela, 2001; Iankova and Katz, 2003; Minor, 2003; Burmester and Tayeb, 2000; Howell, 2002; Miller, 1992)

The prudent approach is based upon early detection and the implementation of appropriate mitigation policies. However, successful execution is contingent upon the efficiency of a firm's internal organization and decision-making regarding its foreign operations, i.e., understanding of politics, knowledge management and strategy. Avoidance of market entry may be an accurate reading of adverse conditions or politicized events in a potential host market. Risk avoidance, however, may be a function of managerial conservatism or inflexibility to exploit highly risky, but profitable opportunities. According to Wernerfelt and Karnani (1987), risk avoidance may take the form of postponement until industry or market uncertainties dissipate.

An exit strategy is the most extreme option available to an international firm. Such action may be caused by various politicized events: consumer boycotts in the home country, e.g., the withdrawal of Barclays Bank from apartheid South Africa; nationalization of assets by host governments, e.g., Exxon Mobil's withdrawal from Venezuela; or sanctions by a home government against a host government, e.g., Halliburton's exit from Iran. (Plummer, 2006; Economist Intelligence Unit, 2008; Simpson and Wilke, 2006) Offset means a firm will absorb the additional costs imposed by risk in a host country. If the value-creation chain is segmented, a firm may focus on profit making in less risky segments and absorb higher costs in more risky segments. (Howell, 2002)

Anticipation is predicated on a firm's intimate understanding of a political system and its ability to use such superior knowledge to avoid risk. For example, Mudambi and Navarra (2003) find that regions in Italy controlled by center-right parties provide superior facilities, opportunities and low risk to foreign investors. However, regions under control of center-left parties offer inferior facilities and higher risk exposure for foreign investors. Participating in the conversion process of a political system may also prevent or mitigate risk exposure. Examples may include information sharing with political organizations; constituency and alliance building with local businesses, consumer groups and NGOs; incentive based offers benefiting stakeholders; and lobbying government decision-makers to change or to dilute risk bearing policies or system outputs. (Hillman and Hitt, 1999; Van Wyk, Dahmer and Custy, 2004)

Risk sharing through bilateral and multilateral agreements allows firms to reduce the uncertainty of potential profit loss. Risk sharing may involve the strategic management and the financial management of risk. Strategic management may include long term agreements with suppliers and buyers, alliances, and international joint ventures. (Allaire and Firsirotu, 1989; Pfeffer and Salancik, 1978) Financial risk management may include forward and future contracts, and political risk insurance. (Hilbert and Jones, 2004; Howell, 2002) Insurance from the Overseas Private Investment Corporation (OPIC) and the Multilateral Investment Guarantee Agency (MIGA) provide leverage to the USA and the World Bank, respectively, to discourage predatory behavior by host governments, e.g., withholding of future aid or loans. Political risk insurance, however, only covers a limited range of business risks including inconvertibility, expropriation, and damages caused by war and civil strife. (Moran and West, 2005)

Risk remedy is a common management policy since disruption of business operations and reduced profitability may not always be avoidable. Often, a firm's own behavior may cause reputational impairment. For example, British Petroleum's image was tarnished among its stakeholders by events such as environmental pollution in Prudhoe Bay, allegations of tax evasion in Russia, and an explosion at its Texas City refinery. Firms may employ various policies to remedy reputational risk: damage assessment, e.g., harm to product quality or financial performance; reality evaluation, e.g., ability to meet expectations of stakeholders; reputation-reality closure, e.g., improvement in corporate communications and public relations; management of changing beliefs and expectations, e.g., development of metrics to measure success; and appointment of senior manager in charge of risk management, e.g., COO, CFO, or Head of Risk Management. (Eccles, Newquest and Schatz, 2007) According to Zsidisin, Ragatz and Melnyk (2005), such post-risk audits accentuate the learning curve and assist in the upgrading of existing and contingency plans to improve coping mechanisms in the face of reoccurring risks. Firms may also seek remedy via legal action. Monsanto, for example, filed a lawsuit in European Union courts against Argentine soybean exporters for losses suffered due to the patent infringement of its Roundup Ready technology for the production of genetically modified soybean seed. (Wall Street Journal, 1/27/06: A7) Finally, in risk management, there will likely be tension between defensive and innovative policies. According to Miller (1992), such uncertainty trade-offs may mitigate risk through sharing policies (e.g., IJVs with state-owned enterprises), but may create divergent interests (e.g., contract breaches) due to the change in political authorities or regimes.

FUTURE RESEARCH

Development of risk, namely the political sources of risk, has been identified as an interdisciplinary subject. An interdisciplinary framework of analysis is proposed, fusing the political science concept of a political system with management science's sequential risk development. Managers may gain a clearer, more integrated understanding of the development of risk and its unfolding impact on the profitability of international firms. Understanding the sequential development of risk also provides firms with the opportunity for the timely identification of politicized events, threats and risks, and the formulation of appropriate policies to defuse or to diminish risk exposure.

The utility of the proposed framework of analysis will obviously require application in individual case studies. Future refinement in terms of risk-generating issues, events and agendas, or risks in particular industries will be a logical progression for knowledge-building in the area of international business risk. For example, the emergence of health pandemics, e.g., HIV/AIDS, SARS, poses a potential risk for companies doing business in emerging markets such as Russia, China, India and South Africa. The obstacles created by rule-makers to move the pandemic from the public to the formal agenda in emerging markets may potentially impose additional costs on firms as surrogate providers of public goods. (Van Wyk, 2007) In the oil industry, the formation of various risks may be tracked more effectively by using the proposed framework. These include challenges presented by the global environmental movement, growing protectionism in industrialized countries, and resurgence of host country nationalization of assets.

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Table 1. Threats to Firm Interests

 Political System Organization Threat
 Function

Conversion Process

Interest * Domestic & * Increased support
Articulation transnational for violence to
 revolutionaries address political
 legitimacy crisis

 * Domestic NGOs * Protests, labor
 strikes

 * Transnational NGOs * Protests against
 globalization,

 capitalism, MNEs

 * Media * Increase in
 negative reporting
 regarding firms

Interest Aggregation * Political parties * Increase in public
 support for parties
 favoring
 protectionism, state
 intervention,
 ideologies other
 than market
 capitalism

Rule Making * Legislatures & * Formulation &
 Executives introduction of
 bills/executive
 orders to increase
 state intervention
 in business

 * Weak institutions

Rule Application * Bureaucratic * Weak institutions
 agencies
 * Decline in
 inefficiency

Rule Adjudication * Judiciary * Legal actions
 against firms

 * Weak institutions

 * Judicial activism

Political * State controlled * Anti-business
Communication media reporting

 * Politicized elites * Negative rhetoric
 regarding business
 (e.g., speeches,
 public statements,
 websites)

System Maintenance &
Adaptation

Socialization * Educational * Curricula
 organizations (e.g., emphasizing
 state, religious) parochialism/
 fundamentalism/
 anti-foreign
 attitudes

Recruitment * Government change * Intention (demand)
 (e.g., & potential support
 constitutional, (resources) for
 unconstitutional increased state
 methods) intervention in
 business

Political Culture * All Organizations * Change in values &
 norms counter to
 market capitalism/
 globalization

 * Subject political
 culture

Table 2. Political System Functions as Strategic Business Risks

 RISK Operations Asset Impairment
 FUNCTIONS

Conversion * Disruption of value * Physical damage
Process creation processes &/or seizure of
 (production, supply facilities due to
 chain) due to civil civil strife
 strife, legitimacy
 crisis or input * Large scale theft
 frustration of inventory

Outputs * Restriction on expat * Restrictions on
Regulative hiring despite skills remittances (profits,
Capability shortage dividends,
 investment capital)
 * Labor market & transfer pricing
 rigidity

 * "Red tape"

 * Decline in business
 facilitation

Extractive * Loss of * Nationalization,
Capability productivity, confiscation,
 efficiency, time & expropriation of
 resources to meet assets (rent-seeking)
 legal compliance
 * Discriminatory
 taxation & audit

 * Corruption of
 gov't officials

Distributive * Gov't policies of * Nationalization,
Capability indigenization confiscation,
 expropriation of
 * IJVs with inefficient assets (wealth
 SOEs redistribution)

 * Poor infrastructure

Responsive * Dominance of * Formal agenda
Capability protectionist groups setting dominated
 (NGOs, labor, by inside access &
 socialist parties in mobilization
 setting formal agenda initiatives to
 for issues (wages , nationalize assets of
 benefits, local private firms
 content of products)

Symbolic * High levels of elite * High levels of
Capability rhetoric in favor of elite rhetoric in
 greater state favor of state
 intervention in firms' ownership of

 RISK Competitive Reputational/Franchise
 FUNCTIONS

Conversion * Precipitous decline * Stakeholder hostility
Process in consumer demand (consumer boycotts) due
 & access to suppliers to firm's actions
 due to political (harmful products,
 instability (internal sweatshops)
 conflict, legitimacy
 crisis) * Political disputes
 between home & host
 countries harm firms

Outputs * Limitations on * Inefficient enforcement
Regulative foreign ownership of contracts & property
Capability laws
 * Trade
 protectionism * Extraterritorial laws
 imposed by home
 * Discrimination in country on its firms'
 gov't procurement foreign operations
 policies

 * Dominant state
 owned enterprises
 (SOE)

Extractive * Discriminatory * High levels of piracy of
Capability taxation & audit intellectual property
 (patents) & counterfeit
 (brand names) by
 competitors &/or gov't
 agencies

Distributive * Higher cost for * Laws requiring foreign
Capability firms acting as firms to share
 surrogates for gov't intellectual property
 in providing public with local firm s
 goods (education,
 health care, * Breach of Contracts
 infrastructure) motivated by wealth
 redistribution

Responsive * Dominance of * Politicization of courts
Capability protectionist/socialist to undermine interests of
 groups to shape firms
 formal agenda on
 business, trade &
 competition

Symbolic * High levels of * High levels of elite
Capability negative elite negative rhetoric
 rhetoric to market directed at foreign firms
 capitalism in favor & the protection of
 of alternative intellectual property
 ideologies

Sequence ? \ Conditions Politicized Threats Risk
Policy ? Events

Avoid ? ? ?
Exit ? ?
Offset ?
Anticipate ? ? ?
Share ? ? ? ?
Remedy ? ?