Managing political risk in cross-national investment: a stakeholder view.

Gao, Yongqiang

Abstract

Political risk originates from the negative actions of social stakeholders of multinational enterprises (MNEs) in a given host country, such as the host government and other non-governmental actors. Further, there are various underlying reasons why the stakeholders take negative actions against MNEs, among them MNEs cannot satisfy or balance the competing interests of different stakeholders play an important role. This paper discusses the political risk in cross-national business from a stakeholder view. The possible negative actions of stakeholders and their reasons are identified. The strategies and tactics to deal with these stakeholders so as to prevent and control political risk are proposed.

Keywords: Multinational enterprise, Adverse action, Political risk, Stakeholder management

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Globalisation brings both chances and challenges to multinational enterprises (MNEs). When MNEs exploit the market or cheaper labour or law in a given host country, they may also confront with an environment completely different from their home country's. The adverse actions conducted by host country individuals or organisations threaten the operation or the survival of MNEs. As a result, risk management is one of the key objectives of MNEs (Ghoshal, 1987). Noncommercial risks, such as war or expropriation, are important elements of risk management in foreign direct investment, which is reflected in the extensive literature on forecasting and managing political risk (for example, Ghadar et al, 1983; Herring, 1983; Kobrin, 1982; Moran, 1998).

The extant literature on political risk, different studies often provide different or conflicting opinions on the definition and scope of political risk, and propose different methods and strategies to forecast and manage political risk. For example, some studies defined political risk in terms of (usually host) government interference with business operations (Kobrin, 1979) and concentrated on adverse governmental actions (Fitzpatrick, 1983), while others define it in a broader sense.

Truitt (1974) argued that "political risks are all 'non-business' risks such as creeping expropriation". Frynas and Mellahi (2003) also argued that all sociopolitical risks are political risk, and thus the political risk contains three types of risks: political risk, government policy risk, and social risk. Furthermore, for a long time, political risk is regarded as exogenous to organisations and MNEs only play a passive role in managing it. As Hadjikhani (2000) noted by citing past research work: "Industrial organisation economics, transaction-cost economics, and studies of internationalisation ... conceive of political actors as an external constraint. Strategies of adaptation and avoidance in management models of international political-risk studies are also based on assumptions of government authority and postulate a passive role for MNCs". However, some studies suggested that MNEs can play a more positive role in controlling or managing political risk (for example, Boddewyn, 1988; Boddewyn and Brewer, 1994; Hadjikhani, 2000; Frynas and Mellahi, 2003).

Such competing opinions on political risk reflect that political risk is still a new topic in international business research, and some well-designed theory or framework about political risk management is still in short supply. Compared to the "macro" political risk such as war, political turmoil, and social riot, MNEs confront more frequently "micro" political risk such as the intervention of host government and other non-governmental actors.

This study focuses on the micro-level of political risk. It aims at identifying the underlying reasons that stakeholders take adverse actions against MNEs and what the actions are, as well as the corresponding strategies and tactics to prevent and control political risk. This study contributes to the present studies in three aspects. First, it introduces the stakeholder management theory into political risk, which can be taken as a step to find a valid theory or framework to clarify the different opinions in previous studies. Second, it discusses political risk from a behavioural angle that previous studies seldom used. It is the behaviour of MNEs and socio-political stakeholders that causes the political risk. A behavioural angle helps us to identify the underlying reasons of political risk and to take corresponding measures. Third, unlike previous studies that focus on the behaviour of the host government exclusively, this paper extends the focus to all the key stakeholders of MNEs.

Literature Review

Although political risk is frequently mentioned in the literature on international business, a consensus on the precise meaning of the term has not yet been achieved (Fitzpatrick, 1983). Fitzpatrick (1983) reviewed the previous studies and identified four categories of definition of political risk. The first category defines political risk in terms of government or sovereign action. The second category identifies political risk in terms of occurrences of a political nature, usually political events or constraints imposed at the specific industry at the specific firm level. The third category is differentiated from the first two by its deeper consideration of the concept of political risk in terms of an environment rather than in isolation. The fourth category is similar to the third but with no detailed definition of a concept of political risk.

Political risk is also defined more precisely but also differently either in terms of environmental change or behaviours of the host government or other social actors. For example, Robock (1971) proposed an operational definition of political risk, "in which political risk in business exists when discontinuities, which are difficult to anticipate, occur in the business environment as a result of political change. These changes in the business environment constitute a risk if they have the potential to affect to a significant extent the profit or other goals of a particular enterprise."

Simon (1982) defined political risk as "governmental or societal actions and policies, originating either within or outside the host country, and negatively affecting either a select group of, or the majority of, foreign business operations and investments." Howell (2001) defined political risk as "the possibility of political decisions or political and social events in a country will affect the business climate in such a way that investors will lose money or not make as much money as they expected".

Although many studies identify host governmental intervention as a source of political risk, it is obvious that governmental intervention is not the sole source of political risk. Simon (1982) contended that political risk can be caused by internal, external, social, and governmental sources. Basing on Simon's (1982) study, Alon and Martin (1998) argued that the sources of macro political risk are internal and external and related to societal, governmental, and economic factors. Mudambi and Navarra (2003) pointed out that "the literature on political risk has mainly been concerned with identifying factors underlying observable government policies towards MNEs. However, such analysis ignores the subtler aspects of the location's business culture (Casson, 1991) and its overall attitude towards MNE investors. These attitudes may be summarised by the political tradition in the location, which can have tangible affects on an MNE even if no policy pronouncements are made explicitly." Clark and Tunaru (2003) noted explicitly that "The nature of political risk is such that it is random and its sources are many and varied. These multiple sources are also dependent upon each other. For example, a tax increase can cause riots or a strike that hurts the company can cause the government to issue a decree that satisfies labor's demands but that also hurts the company. Similar relationships to one degree or another exist between most political variables." These studies suggest that host governmental intervention is one of sources of political risk. A thorough analysis of sources of political risk should identify other actor's behaviour.

The mainstream literature on political risk literature takes the political environment as given and exogenous, and MNEs act as a passive role in managing it (Hadjikhani, 2000). As a result, the prescriptions for MNEs to treat political risk include avoiding or retreating from a given host country or purchasing insurance to transfer political risk from MNEs to insurance agents basing on risk assessment. However, the popularly used political risk assessment models have a number of deficiencies from the standpoint of the company (Alon and Martin, 1998). The most important deficiency should be their error in forecasting major political events. Kennedy (1987) showed that many of the major organisations which perform political risk assessment failed to forecast the Iranian revolution. Moreover, some political risks may be related to the behaviours of MNEs, which cannot be forecast depending on external political risk assessment. For instance, Makhija (1993) pointed out that if the firm's operations impede the host government objects, government intervention is predictable. Some studies also argued that some behaviours or characteristics of MNEs may be associated with political risks in developing countries (for example, Kim, 1988; Poynter, 1982).

The variables that have been frequently discussed include: public relations intensity, number of host nationals in total employee pool, number of host nationals in executive/management positions, level of commitment for community development, significant host government contacts initiated by firms, level of commitment for occupational health and safety of the host employees, and amount of job training and education for host nationals (Kim, 1988). It indicates that political risk assessment should think over the behaviours of MNEs.

Realising the endogenesis of political risk, some authors contended that MNEs can play a more positive role in manipulating the political environment or managing political risk (Boddewyn, 1988; Boddewyn and Brewer, 1994; Hadjikhani, 2000; Frynas and Mellahi, 2003). Booth (1993) suggested that if MNEs are faced with general coercive force, they should take "adaptation" strategy. In studying the general coercive actions and the responses of the business actors, Boddewyn (1988) discussed the "negotiation" strategy and the role of mediary actors when business actors try to manage problems with political actors. However, when the political risk is sudden, such as in a political crisis, the mediary actors lose their positions and legitimacy. For such a turbulence, which can be firm-specific, the exit strategy is proposed by some authors because of the focused hostile actions of the government (Makhija, 1993). On the other hand, some researchers advise against exiting and advocate firms to increase their commitment (Staw, 1982), hoping that the increased commitment will improve host government's attitude. These studies indicate that MNEs can take a positive role in managing political risk. However, systematic analysis on the strategies or tactics in managing political risk is still in short supply.

This article introduces stakeholder theory into the study of political risk. It discusses political risk from the interaction between MNE's and its stakeholders' behaviour. In this article, political risk is defined in terms of its source. It is defined as "the adverse action of MNE's stakeholders in a given host country". Why did those stakeholders take adverse action against MNE? What are the possible adverse actions? And what are the appropriate strategies and actions to deal with political risk? These questions are analysed in this article.

Political Risk: The Stakeholder Framework

The stakeholder theory argues that the organisation has relationships with many constituent groups and that it can engender and maintain the support of these groups by considering and balancing their relevant interests (Evan and Freeman, 1993; Freeman, 1984; Jones and Wicks, 1999). In general, the stakeholder theory advises management to keep the relationships among stakeholders in balance. When these relationships become imbalanced, some stakeholder may set fire and bring risk to the firm. As a result, the survival of the firm is in jeopardy (Freeman, 1998).

However, the stakeholder theory advocates that management pays more attention to the potentially important stakeholders. Which stakeholders do and do not deserve or require management attention depends on the evaluation of relationships between organisations and stakeholders based on exchange transactions, power dependencies, legitimacy claims, or other claims (Mitchell et al, 1997). Through identification, evaluation, and assessment of stakeholders and stakeholder relationships, firms can best navigate the public and private strategic environments in which they operate, and in so doing, account for the range of relationships, responsibilities, and interaction in their strategy formulation and implementation (Cummings and Doh, 2000).

In the stakeholder literature, there is a line of argument that anyone or anything that is affected by the organisation's activities--including animals, fish, and inanimate objects--are all potential stakeholders (Starik, 1994). Alternatively, there is also a more limited view that defines stakeholders as those groups or individuals that are in some mutually dependent relationship that, if not dealt with properly, may lower corporate performance (Nasi et al., 1997). An example of the limited view of stakeholder is Carroll (1996) who defined stakeholder as "any individual or group who can affect and is affected by the actions, decisions, policies, practices, or goals of the organisation." For the purpose of this study, the limited view of the stakeholder is more suitable.

Specifically, the typical stakeholders of business are also identified in the literature. Freeman (1983) proposed two definitions of stakeholder: a wide sense and a narrow sense. In the wide sense definition, the stakeholders of business include: public interest groups, protest groups, government agencies, trade associations, competitors, unions, employees, customer segments, share owners, and others.

In the narrow definition, the stakeholders include: employees, customer segments, certain suppliers, key government agencies, shareowners, certain financial institutions, and others. Donaldson and Preston (1995) proposed a stakeholder model of the corporation in which eight stakeholders are identified. The stakeholders include: governments, political groups, investors, suppliers, customers, employees, trade associations, and communities. Similarly, the typical stakeholders of business identified by Carroll (1996) are consumers, suppliers, government, competitors, communities, employees, and stockholders.

Keeping in mind that political risk is the stakeholders' adverse action against MNEs and integrating the above arguments, this article contends that the typical stakeholders of MNEs mainly include: host government, host employees and labour union, host supplier, customers/consumers, host competitors and trade association, communities, and other non-governmental organisations (NGOs), opposition party, and criminal gangs.

Why those stakeholders take adverse actions against MNE can be observed in the "gap" that the actual performance of MNE lags the expectation of those stakeholders on them. The stakeholder framework of political risk I proposed is illustrated in Figure 1.

Identifying Stakeholders" Interests on MNEs

In many cases, the political risk is industry-specific or firm-specific. Some MNEs may suffer losses resulting from the adverse action of the host government and other stakeholders, while others may not be influenced. The underlying reason that stakeholders act against some MNEs and not against others lies in MNEs' failing to satisfy the request of the stakeholders or the interests of MNEs' conflicts with the stakeholders'. As a result, identification of the stakeholders' requests or interests on the MNEs acts as a first step to manage political risk.

[FIGURE 1 OMITTED]

Different stakeholders have different requests or interests on MNEs (see Table 1). For example, the host government may wish MNEs to invest in the host country so as to speed the economic development, to increase employment, and to abide by laws and regulations. Host employees and labour union focus their attention on the benefits of host employees. Communities and other NGOs wish MNEs to be a responsible corporate citizen in host country: to comply with laws, regulations and business routines; to respect local culture, and to support charities and causes.

Host competitors and trade association ask MNE to compete fairly and to maintain a relative balance in the industrial structure. Host suppliers desire MNEs to localise purchase for raw materials or components, while customers or consumers hope that MNEs provide high quality goods or services at reasonable prices. The opposition party and criminal gangs may take MNEs as a tool to realise their specific goals. However, those goals are difficult to identify.

The interests of different stakeholders on MNEs may be consistent. For example, almost all stakeholders wish MNEs to be a good corporate citizen in the host country: to abide by the host country's laws, regulations and business routines; to respect host country's social and commercial culture; to support host country's charities; to develop host country's economy, and increase employment. However, the interests of different stakeholders may also conflict with each other in some cases. For instance, local customers or consumers wish MNEs to compete fully with local enterprises so that they can enjoy high quality goods and services at lower prices. But host competitors and trade associations may be dissatisfied since their interest is challenged or even their survival is threatened. As a consequence, MNEs should develop different strategies to deal with the "consistent" interests and "conflicting" interests respectively.

Dissatisfied stakeholders or where interests have been overlooked stakeholders may invoke adverse actions against MNEs and thus result in political risk.

Adverse Actions of Stakeholders

As discussed previously, the adverse actions of stakeholders against MNEs are the source of political risk. In the literature, the host government's intervention in the operation of MNEs has been widely identified as source of political risk (Fitzpatrick, 1983; Kobrin, 1979). However, the actions of other stakeholders against MNEs are largely overlooked. In fact, different stakeholders may take different actions against MNE (see Table 2). For instance, the host government may nationalise MNEs or impose various restrictions on the operations of MNEs; host employees and labour union may organise a strike against MNEs; NGOs in host country may publish negative reports against MNEs; host competitors may lobby or press host government to control imports and establish new entry barriers; local customers or consumers may boycott MNE's goods or services; and criminal gangs may rob and kidnap MNE's employees.

Clearly, the adverse actions of stakeholders act on MNEs by two ways: (a) a direct way that stakeholders take adverse actions against MNEs directly. For example, the host government formulates new regulations on MNEs or the labour union organises a strike against the MNE. (b) An indirect way that non-governmental stakeholders lobby or press host government to take actions against the MNEs.

[FIGURE 2 OMITTED]

The distinction between these two approaches has important implication for MNEs to manage political risk. Some previous studies only take the host government as the originator of political risk for MNEs, they neglect the fact that in some cases the host government only acts as a tool or middleperson in which competitors or other non-governmental actors act as the real manipulator. Therefore, political risk management should not only pay attention to the host government, but also to the non-governmental actors who act as the initiator behind the curtain.

Political Risk Management: Strategies and Tactics

Some scholars argue that MNEs can play a more active role in managing political risk have proposed relevant strategies or tactics to deal with political risk. For example, Oliver (1991) suggested that firms can take compliance, evasion, negotiation, cooperation, coalition building, and cooption strategies to cope with the host government. Similarly, Boddewyn and Brewer (1994) argued that different types of MNEs should develop differentiated economic, political, and social responses towards competitors, customers, suppliers, governments, and other nonmarket stakeholders. Furthermore, the authors proposed five forms of political behaviour to deal with government, that is, compliance, avoidance, circumvention, conflict, and partnership.

However, previous studies on political risk management have several deficiencies. At first, most previous studies on political responses of firms are limited to a given country, such as Oliver's (1991), whether the behaviours can be extended to the international business situation or not need to be tested further.

Secondly, some studies, for example, Boddewyn and Brewer's (1994), have discussed the political behaviours of MNEs in a given host country. However, the behaviours of MNEs discussed by the authors only targets host government other than other stakeholders.

Thirdly, the strategies or behaviours of MNEs proposed in previous studies are based on the bargaining power of MNEs against the host government. Those strategies or tactics may not be suitable for MNEs to manage political risk. For example, as previous studies suggested, MNEs with high bargaining power against the host government may take "conflict" behaviour and ask the host government to make concession. However, such behaviour may spell trouble for the MNEs in the long term.

This study proposes the proper strategies and tactics that aim at preventing and controlling adverse actions of stakeholders of MNEs in the long term. As the stakeholder theory indicates, the core idea of political risk management is to consider, satisfy, and balance the interests of all stakeholders. Since different stakeholders have either consistent or competing interests on MNEs, the strategies and tactics I proposed here either satisfy the consistent interests (aiming at preventing political risk) or mediate the competing interests (aiming at alleviating the negative effect of political risk) (See Table 3).

Defensive Strategy

Defensive strategy aims at guarding against an adverse action of stakeholders. The tactics included in this strategy are self constraint of MNEs, commitment, balance, and cooperation.

The MNEs' misconducts act as an important source of political risk. Acts such as bribery, tax dodging, environmental pollution, running sweatshops, dumping, unfair competition, and so forth in the host country, are deemed to cause political risk (Gao, 2007). As a consequence, self constraint of conduct acts as an important tool to prevent MNEs from political risk.

Commitment is also an important approach to get the support of the host government and NGOs (Hung, 2002). In studying foreign enterprises in China, Chen (2004) proposed four different commitments. The first is to increase their investments in China. The second is to use their advanced technologies and management techniques for the betterment of Chinese society. The third is to devote themselves to communities and social affairs. The last approach is to localise multinationals' practices in China by hiring and training Chinese employees. Although Chen's study focuses on MNEs in China, his suggestion can be adapted to other countries.

Balance means that MNEs should consider the interests of all stakeholders simultaneously. The host government is the visible actor of political risk, but other stakeholders may act as the manipulator behind the curtain. Therefore, MNEs should try to satisfy the interest of the host government, as well as those of other stakeholders.

Cooperation is a tactic recommended by some scholars in dealing with the host government (Oliver, 1991; Boddewyn and Brewer, 1994). Cooperation means that MNEs bind their interest with those of the stakeholders, so as to avoid their adverse actions. The cooperative forms are various, depending on the different types of partners. For example, MNEs can cooperate with the host government to develop the local economy; can set up joint ventures with host competitors; can purchase raw materials from host suppliers; can cooperate with communities and environmentalists to improve environmental quality; and so forth. Management of MNEs should keep in mind that with better bonding with the host stakeholders, there is less possibility that they take adverse actions against the MNEs.

Controlling Strategy

Controlling strategy aims at alleviating or relieving the negative effect after a political risk has taken place. Four tactics are included in this strategy. They are giving priority to powerful stakeholders, coalition building, using mediator, and turning to external forces.

Stakeholders may have competing or conflicting interests with MNEs. MNEs cannot eliminate this conflict but they can alleviate the negative effects of such a conflict by giving priority to the interest of powerful stakeholders. Therefore, giving differential treatment to different stakeholders should be an important factor to control political risk.

In some cases, adverse actions of stakeholders may act on some MNEs or on the whole industry. Under those situations, MNEs can build coalitions with those who have the same interest and to strengthen their bargaining power against the stakeholders. Coalition building is also recommended by Oliver (1991). An example of coalition building is for MNEs to bargain with host government Gao (2008) is found that 54 foreign companies formed a coalition to bargain with the State Council of China when they heard that the latter wanted to integrate income tax for domestic and foreign companies (foreign companies enjoy revenue alleviation in China since 1978, the income tax rate for domestic firms is 33 per cent while that for foreign companies is 15 per cent) and to increase the income tax rate of foreign companies in 2004.

A mediator is often needed when the bilateral relationship between an MNE and its stakeholders is under tension (Boddewyn, 1988). In fact, mediation is the most used tactic in resolving disputes in international business.

In addition to using mediators, MNEs can also turn to external forces. The main external forces are the business partners in the host country and the home government. Since the stakeholder management results in profits for some stakeholders and losses for others, MNEs can resort to the satisfied stakeholders to deal with the dissatisfied. Moreover, MNEs can ask their home government to negotiate with the host government so as to reduce its intervention in the operations of MNEs.

Conclusion

Accompanying the emergence of globalisation, political risk has become a hot topic in the academia of international business. Compared to the overall political risk such as war or political turmoil, some political risk may be industry-specific or firm-specific, due to the intervention of the host government or the adverse actions of other non-governmental actors.

MNEs should aim at building long-term good relationship with all the stakeholders and avoiding their adverse actions against them, by considering and balancing all the stakeholders' interests. However, in some cases, MNEs cannot meet the claims of stakeholders because the claims are too much or different claims compete with each other. Under such situations, a political risk may take place. Then MNEs should take controlling strategies to alleviate the negative effect of such political risks.

This study is financially supported by the Humanity & Social Science Fund of Education Ministry of China (No 06JC630011).

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Yongqiang Gao

Huazhong University of Science & Technology, Wuhan

Table 1: Key Interests of Stakeholders on MNEs

    Stakeholders                    Key Interests on MNEs

Host government         Making investment commitment;
                        Increasing employment;
                        Abiding by laws and regulations.

Host employees/         Complying with labour policies;
Labour union            Improving host employees' welfare.

Community and           Complying with laws, regulations and
other NGOs              business routines;
                        Respecting local social and commercial
                        culture;
                        Supporting education, environmental
                        protection, sports, and other charities;
                        To be a responsible corporate citizen.

Host competitors/       Fair competition;
Trade association       Maintaining a relative balance in industrial
                        structure.

Host suppliers          Localisation of purchase for raw materials
                        or components.

Customers/Consumers     Providing high quality goods or services
                        at reasonable price.

Opposition party/       MNE is taken as a tool to realise specific
Criminal gangs          but hard to be identified goals.

Table 2: Typical Adverse Actions of Stakeholders against MNEs

Stakeholders          Typical Adverse Actions

Host government       Nationalisation or exproriation;
                      Restrictions on remittance, imports or
                      exports, and operations;
                      Price controls;
                      Taxation discrimination;
                      Discrimination in purchase policy;
                      Anti-MNE rules; etc.

Host employees/       Organise a strike against the MNE;
Labour union          Lobby or press host government to impose
                      restrictions on the operation of MNEs.

Communities and       Publish negative reports against MNEs;
other NGOs            Advocate the public to boycott MNEs goods or
                      services; Lobby or press host government to
                      impose restrictions on MNEs.

Customers/            Lobby or press host government to impose
consumers             restrictions on MNEs.
                      Boycott MNEs goods or services.

Opposition party/     Stage a coup d' tat which threatens MNEs
fraction, Criminal    interest; Launch a civil war;
gang                  Rob and kidnap employees of MNE;
                      Destroy physical facilities of MNE.

Table 3: Strategies and Tactics in Political Risk Management

Strategies                 Tactics                 Explanation

Defensive strategy     * Self constraint of MNE;   Defensive strategy
                       * Commitment;               aims at guarding
                       * Balance:                  against an adverse
                       * Cooperation.              action of
                                                   stakeholders.

Controlling strategy   * Giving priority to        Controlling strategy
                         powerful stakeholders;    aims at alleviating
                       * Coalition building;       or relieving the
                       * Using mediator;           negative effect
                       * Turning to external       after a political
                         forces.                   risk has taken
                                                   place.