how to minimize political risk essay

• Contributors

The Management of Political Risk

Campbell R. Harvey  is Professor of Finance at the Fuqua School of Business at Duke University. This post is largely based on a recent article, forthcoming in the Journal of International Business Studies,  by Professor Harvey;  Erasmo Giambona , the Michael Falcone Chair in Real Estate at the Whitman School of Management at Syracuse University; and  John R. Graham , Professor of Finance at the Fuqua School of Business at Duke University. The complete article, including appendix, figures, and tables, is available here .

We explore a long standing prediction in the international business literature that managers’ subjective perceptions of political risk—not just the level of risk—are important for how firms manage political risk. The importance attributed to political risk by corporate executives has increased over the last 15 years and our results show that political risk is now considered more important than commodity (input) risk. Our analysis suggests that nearly 50% of firms avoid (not simply reduce) foreign direct investment because of political risk. Using a unique survey‐based psychometric evaluation of manager risk aversion, we show that firms with risk averse executives are more likely to avoid investment in politically risky countries—a key implication of behavioral models. This relation is economically stronger when agency problems are more likely to be severe: for example, when executives are less aligned with shareholder value maximization, and when executives are younger (and therefore might put their personal career’ concerns in front of shareholders’ interests). While numerous studies have shown that political risk affects foreign direct investment using objective measures of such risk (electoral uncertainty, conflicts, etc.), our study documents that executives’ subjective perceptions of political risk are also important for political risk management.

1. Introduction

How does political risk affect foreign direct investment (FDI)? In an influential study, Kobrin (1979) argues that political risk affects FDI by increasing the uncertainty that firms face in a foreign country. To investigate this relation empirically, researchers have traditionally used objective measures of political risk, including 1) electoral uncertainty 2) conflict risks, 3) social unrest, 4) corruption, 5) political instability, 6) quality of the institutions in the host country, 7) sovereign debt default risk, and 8) market imperfections. [1] In this post, we address a classic research challenge put forth by Kobrin (1979); namely, we attempt to directly assess “what affects managers’ subjective perceptions” of political risk. To overcome the difficulty in measuring subjective preferences, we administer a psychometric test to evaluate the risk aversion of individual executives. We show that the personal risk aversion of executives is a significant factor explaining how their companies respond to political risk.

We study these issues within the context of behavioral theory (e.g., Johnson and Tversky, 1983; Slovic, 1987) and agency theory (e.g., Stulz, 1984; and Smith and Stulz, 1985). Behavioral models predict that it is not just the level of political risk that is important, it is also the individual manager’s sensitivity to that risk that dictates the corporate response to political risk. According to agency theory, corporate decisions are more likely to reflect the best interests of executives (rather than the best interests of shareholders) when managers’ interests are less aligned with those of stockholders. Thus, corporate risk management decisions will reflect an executive’s personal sensitivity to political risk in firms in which executives indicate that they are less concerned about the interest of stockholders and in firms managed by younger executives—who put their own career concerns ahead of the interests of shareholders. We develop these two main hypotheses, one behavioral and one agency‐driven, in more detail in the next section.

In our empirical work, we find that nearly half of the executives in our sample say that they avoid investing in a risky country altogether as a way to manage political risk. Consistent with a behavioral prediction, we find that companies with highly risk‐averse financial executives are more likely to avoid investment in politically risky countries. That is, a manager’s subjective perception of political risk affects her firm’s decision to avoid investment in a politically risky country. Consistent with an agency theory prediction, we find that the effect of risk aversion on a firm’s decision to avoid investing in a politically risky country is stronger for executives who are less concerned about stockholder welfare, and is also stronger for younger executives.

While numerous studies have documented the effect political risk on FDI using objective measures of such risk (conflicts, social unrest, electoral uncertainty, etc.), our post documents that a manager’s subjective perception of political risk is also important for how firms manage political risk.

The post is organized as follows. We develop our hypotheses in section 2. The data are described in the third section. The fourth section presents empirical results. Some concluding remarks are made in the final section. The survey questions are in the appendix (available here ).

2. Hypotheses’ Development

In this section, we develop the two hypotheses that we test in this study.

Behavioral‐Theory Hypothesis: A l l else equal , firms with risk averse executives are more likely to avoid investing in politically risky countries .

Traditional economic theory typically views managers as homogeneous and always making decisions in the best interest of shareholders. In contract, according to behavioral theory, the characteristics of the individual manager can affect how an executive manages her firm (Johnson and Tversky, 1983; Slovic, 1987; Gervais, Heaton, and Odean, 2011; Palomino and Sadrieh, 2011). Hence, behavioral theory predicts that firms with risk averse executives might adopt more conservative corporate policies because such policies fit the personal risk profiles of the executives.

Agency‐Theory Hypothesis : firms with risk averse executives are more likely to avoid investing in politically risky countries if the executives are less inclined to manage the firm in the interest of shareholders and if the executives are young .

Agency theory explores, among other things, conflicts that exist between managers and shareholders when their interests are not aligned. Agency theory suggests that the degree of misalignment between managers’ and shareholders’ incentives can exacerbate the degree to which managers make decisions more reflective of their own interests than those of shareholders. [2] For example, the degree to which risk averse executives implement corporate risk management according to their personal risk preferences is stronger when agency conflicts are particularly acute (Stulz, 1984; Smith and Stulz, 1985; Holmström and Ricart I Costa, 1986; and Ross, 2004). We quantify the degree of agency conflicts between managers and stockholders in two ways: 1) the degree to which executives indicate on a survey that they are relatively less concerned about the interest of stockholders (and relatively more concerned about other stakeholders), and 2) by the age of the executive (Gormley and Matsa (2016) show that younger executives are more likely to “play it safe” and make risk‐reducing investments due to agency‐driven career concerns).

We discuss tests related to these predictions in section 4.4.

3.1. The Data Gathering Process

Our data are gathered from a large scale survey of financial executives around the globe. Emails were obtained from four different sources: CFO Magazine, International Swaps and Derivatives Association (ISDA), the Global Association of Risk Professionals (GARP), and Duke University. We invited financial executives to take part in the survey via emails sent in the last week of February 2010. Reminder emails were sent throughout March 2010. The survey closed at the end of April 2010.

The invitations were sent to about 29,000 executives and we gathered 1,161 responses. While the response rate seems low, we only asked a small subset of the 29,000 to respond—those that had decision‐making authority for risk management. For example, in the invitation sample, very few of the recipients for the ISDA and GARP lists had the authority of a Chief Financial Officer, Chief Risk Officer, Vice‐President‐Finance or Treasurer and therefore declined to participate. Below we examine the representativeness of our respondents.

Figure 1 of the complete paper (available here ) shows the geographic distribution of the corporate headquarters for our sample, with the majority of respondents coming from North America and the rest from Europe and Asia. [3] In addition to obtaining information on the risk management practices at our sample firms, we also collect demographic information on company and risk manager characteristics.

3.2. The sample

We obtain data on political risk exposure from a corporate risk management survey that explores six different types of risk. [4] So as not to burden the respondents, the survey branched in a manner that no respondent was required to answer all the questions. The survey contains a set of common questions that all participants answer (such as demographic information). Given there are six areas of risk, we randomized the invitation so that each participant focused on three risk areas. [5] As a result, the political risk sample is smaller than the overall sample. The survey questions related to political risk are in the appendix.

In the survey, we focus on political risk broadly defined, which includes macro political risks (e.g., regime changes or nationwide security breakdowns), micro political risks (e.g., security problems arising in a certain region of a country or related to certain policies), and external political risk (which is related to tensions between countries).

We collect information on the following demographic characteristics. Risk aversion is an indicator equal to 1 if the CFO answers a series of questions indicating a preference for stable salary over riskier but higher expected value pay. [6]  We rate the degree to which management is concerned in stockholder’s interest on a scale of 0 (the firm is not at all managed in the interest of stockholders) to 100 (firms is managed entirely in the interest of stockholders). Executive is Younger than 45 is an indicator for executives younger than age 45. Large is an indicator for firms with revenue greater than US$1 billion. Ratings is a zero‐one variable indicating whether the firm’s debt is rated. Dividend Payer is a dummy variable that takes on the value of one if the company regularly pays dividends. Profitable is an indicator for firms that reported a profit in the previous fiscal year. Cash Holdings is the ratio of cash and marketable securities scaled by total assets. Leverage is the ratio of total debt to total assets. Investment Prospects are rated on a scale of 0 (no growth prospects) to 100 (excellent prospects). Public is an indicator for firms traded on a stock exchange.

Table 1 of the complete paper (available here ) presents summary statistics for the full sample. On average, executives rate their concern about the interests of stockholders at 61. About 44% of executives are younger than 45, 38% of our sample firms are large, 55% have rated debt, and 54% pay dividends regularly. Nearly four‐in‐five firms are profitable and the average investment prospects rating is 65.

Given this demographic information, we compare the public firms in our sample (567 firms) to a standard archival database, Global Compustat (23,700 companies analyzed at the time of the survey). Table 1 shows that our public sample firms are similar to this benchmark. For example, our sample has 56% large firms whereas Compustat has 48%. For both our sample and Compustat, 20% of firms report a loss in the previous year. The samples are roughly similar in terms of cash holdings and leverage.

Private firms make up half (51%) of our sample. The final column in Table 1 allows us to compare demographic characteristics of public and private firms. Private firms are similar to public firms for many of the key characteristics: cash holdings, leverage, profitability, and investment prospects. Private firms are less likely to pay a regular dividend. Unsurprisingly, private firms are smaller and they are less likely to have rated debt.

4.1. Time‐Series of the Perceived Importance of Political Risk

Table 2 of the complete paper (available here ) shows that the executives in our sample believe that the importance of political risk increased in the four years leading up to the survey. Panel A shows that 54% of participants believe political risk has increased, whereas only 8.4% believe it has decreased. We are, of course, measuring the perception of political risk. These perceptions are likely correlated with empirical proxies or risk realizations such as those used in Barro (1991). The advantage of our measure is that perceptions are likely aggregating information across many different risk factors whose importance may change through time. Panel B shows that active management of political risk has followed the increased exposure. Nearly 50% of executives have increased their management of political risk, whereas only 4% have decreased it. Both panels provide separate analyses by region and show that political risk has increased in every region and in response executives have increased the management of such risk.

4.2. Political Risk vs. Other Material Risks

How do financial executives perceive the importance of political risk compared to other material business risks?  Panel A of Figure 2 shows that the three most important risks are interest rate risk, foreign exchange risk, and credit risk. Political risk ranks fourth. Interestingly, financial executives consider political risk to be more important than either commodity or energy risk.

Panel B of Figure 2 examines political risk exposure of companies headquartered in different regions of the world. While there is some variation by region, the broad message is that political risk exposures are similar across regions (U.S. 31%, Europe 33%, and Asia 26%). Figure 2 also indicates that financial firms indicate that they have higher exposure to political risk than non‐financial firms.

4.3. How Firms Manage Political Risk

In this section we study how firms manage political risk, which provides context for testing the hypotheses developed in Section 2. The most popular way to manage political risk is to simply avoid investing in risky countries (48.6% of respondents; see Table 3 ,   available here ). This evidence is consistent with theoretical predictions (e.g., Pastor and Veronesi, 2012, 2013; and Bernanke, 1983) and indicates that there are significant real effects associated with political risk. Moreover, because we ask CFOs directly whether they reduce investment in risky countries in response to political risk, we are able to establish a direct link between political risk and FDI. In contrast, archival data studies cannot determine whether political uncertainty is the outcome of (or the cause of) low growth, [7] which makes it difficult to identify whether the reduction in foreign direct investment is the consequence of political uncertainty. [8]

Firms that do invest take actions to mitigate the effect of political risk on FDI. Table 3 reveals that a sizable 40% of firms increase their due diligence before investing in risky countries, and another 40% actively diversify investment across countries. Firms use other methods to manage political risk, including, partnering with local firms (35% of respondents), increasing the hurdle rate (25%), [9] and relying on political risk insurance (15).

4.4. Behavioral Theory, Agency Effects, and Corporate Political Risk Management

In this section, we explore our behavioral‐theory hypothesis by examining whether managerial risk aversion modifies the most popular approach (avoiding investment altogether) that firms use to manage political risk. Later, we also study a second (agency theory) hypothesis of whether this risk aversion/avoid investment relation is stronger when agency problems are more severe. We test these predictions by estimating the following probit model:

where Avoid Investment in Risky Countries is a 0/1 variable set to 1 when firm i indicates that it deals with the level of political risk by avoiding foreign direct investment in risky countries, and α is a constant. We account for heterogeneity across regions by including regional dummies in all regressions . All standard errors are heteroskedasticity consistent and clustered by region.

Table 4  (available here ), column 1 presents results from the estimation of Eq. (1) for the sample of non‐financial firms. Consistent with our behavioral theory prediction, we find that the coefficient on Risk Averse is positive and statistically significant at the one percent level. The effect is also economically sizable. The marginal effect of 0.10 indicates that firms with risk averse executives are 10% more likely to avoid politically risky countries altogether. This finding documents the importance of executives’ subjective perceptions (as measured by their risk aversion) of political risk in modifying the degree to which their firms avoid investing in politically risk countries.

Turning to the control variables, Table 4 shows that large firms are more likely to deal with political risk by avoiding foreign direct investment in risky countries. This could occur because larger firms have the scale and the organizational structure necessary to relocate investment activities when political risk exceeds an acceptable threshold or pursue some of the other strategies documented in the article. Among non‐financial firms, dividend payers are more likely to avoid FDI in risky countries, while more profitable firms and those with higher cash holdings are less likely to do so.

Our agency theory prediction is that the effect of risk aversion on a firm’s decision to avoid politically risky investment is stronger when agency problems are more severe. To test this prediction, we ask executives to tell us on a scale from 0 to 100 to what extent they run the firm in the interest of shareholders (where 100 means the firm is run in the exclusive interest of shareholders). We then separate firms in two groups depending on whether the executive response is below or above the overall sample mean of 61. Separately, we partition firms in two groups depending on whether executives are younger or older than 45, to test whether subjective preferences are more relevant for younger executives; as stated above, the career concerns of younger executives might lead to more severe agency conflicts with shareholders. Table 4, columns 2–5, report results for these subsamples.

Consistent with our agency theory prediction, Risk Averse enters the probit estimation with a positively significant coefficient when agency problems are more severe: When executives rate the interest of shareholders below the sample mean (column 2) and for younger executives (column 5). Further, the marginal effects of 0.36 and 0.44 (columns 2 and 5) indicate that the effect of risk aversion on a firm’s decision to avoid investing in a risky country is economically sizable: Firms with risk averse executives and relatively worse agency issues are about 40% more likely to avoid investing politically risky countries. Conversely, risk aversion does not play a role in corporate decision‐making in firms with less severe agency issues by these measures (the insignificant coefficients in columns 3 and 5). [10]

Overall, the evidence in Tables 4 indicates that executives’ subjective perceptions of political risk have important consequences for political risk management via both behavioral and agency channels.

5. Conclusions

There is an abundant literature on the effect of political risk on foreign direct investment. The common denominator of these studies is that they rely on objective measures of political risk, such as conflicts, electoral uncertainty, social unrest, etc. According to theory, executives’ subjective perception of political risk affects how firms manage political risk. This idea was first posed as a research challenge in Kobrin (1979) but has gone untested until now because data on managerial risk perceptions are not readily available. In our article, we perform a psychometric test on sitting executives to obtain data on the personal risk aversion of executives.

Consistent with behavioral theory, we find that firms with risk averse executives are more likely to avoid investment in politically risky countries. We also find that the effect of risk aversion on a firm’s decision to avoid investing in politically risky countries is most evident when agency problems appear to be more severe.

Our study uncovers: (1) an important link between executive risk aversion and FDI and (2) the mechanisms through which the executives’ perceptions of political risk affect their firms’ political risk management. We hope our findings stimulate researchers to further explore the relation between executives’ personal characteristics and companies’ investment policies in politically risky countries.

The complete article, including appendix, figures, and tables, is available here .

[1]  Citations to this list of objective measures follow: 1) Vaaler, Schrage, and Block, 2005; Henisz and Zelner, 2010; and Julio and Yook, 2012; 2) Nigh, 1985; Barro, 1991; Globerman and Shapiro, 2003; and Darendeli and Hill, 2016; 3) Li and Resnick, 2003; 4) Wei, 2000; Habib and Zurawick, 2002; and Uhlenbruck, Rodriguez, Doh, and Eden, 2006; 5) Loree and Guisinger, 1995; Sethi, Gusinger, Phelan, and Berg, 2003; Baker, Bloom, and Davis, 2013; Brogaard and Detzel, 2012; and Brogaard, Dai, Ngo, and Zhang, 2014; 6) Alfaro, Kalemli‐Ozcan, and Volosovych, 2008, 7) Citron and Nickelsburg, 1987; and 8) Brewer, 1993. (go back)

[2]  Managers are exposed to the financial conditions of their firms through employment. As Eckbo, Thorburn, and Wang (2016) show, CEOs who lose their executive job because of bankruptcy suffer a long‐lasting compensation loss. These potential personal losses explain how the executives’ personal interests can influence corporate policies. (go back)

[3]  There are a small number of firms from other regions, including Australia and New Zealand, Latin America, the Middle East, and Africa. (go back)

[4]  In a companion paper, Bodnar, Giambona, Graham, Harvey, and Marston (2014) examine corporate risk management in the context of FX, interest rate, commodity, credit and energy risks. (go back)

[5]  The survey contained branches that were designed to obtain broad information without overly burdening respondents. All survey participants that indicated that they faced material foreign exchange risk answered FX questions and likewise for IR risk. With respect to political, energy, commodity, and credit risk, if a respondent indicated that her firm primarily faced material political risk from among these four categories, she answered just the political risk questions (and likewise for the other three categories). If the respondent chose multiple categories of material risk from among the four, she was randomly assigned to answer questions in the category among these four that had the least number of cumulative responses based on the choices made by previous respondents. (go back)

[6]  Following Graham, Harvey, and Puri (2013), and Bodnar, Giambona, Graham, and Harvey (2014), we ask CFOs that currently earn $X to choose between two new jobs: (1) 100% chance job pays $X for life; (2) 50% chance job  pays $2X for life and 50% chance job pays $2/3 X for life. If the CFO selects (1), we ask her to choose between the two following job alternatives: (3) 100% chance job pays $X for life; (4) 50% chance job pays $2X for life and  50% chance job pays $4/5 X for life. To mitigate the “status quo bias” (Barsky, Kimball, Juster, and Shapiro, 1997), which could make individuals prefer the current job to avoid the costs involved with the search of a new job, we tell respondents that they have to move to a new location and change job because of health reasons. We categorize the financial executives that choose the sequence (1) and (3) as risk averse. (go back)

[7]  See, among others, Brewer, 1983, 1993; Habib and Zurawicki, 2002; Globerman and Shapiro, 2003; Alfaro, Kalemli‐Ozcan, and Volosovych, 2008; Anshuman, Martin, and Titman, 2011; Julio and Yook, 2012. (go back)

[8]  The finding that a large number of financial executives simply avoid investing in politically risky countries raises another potential econometric issue (selection bias) with archival‐data studies. Consider a politically risky country and assume that there are some firms investing in the country. There are also many other firms that avoid investing in the country because political risk is above their acceptable threshold. A regression analysis of FDI on political risk may underestimate the impact of changes in political risk if one were to focus on the sample of companies that are already present in the country. To see why, consider an improvement in political risk that takes the country across the investment threshold. The amount of investment would jump much more than predicted by the regression model because many new companies would enter the country. Our approach avoids this issue. Using simulated data, we find that FDI sensitivity to political risk is 50% higher in a scenario where new firms are allowed to enter a country if political risk falls below a certain threshold (which we note is very close to our survey data approach) compared to a scenario where the number of firms is fixed (which is very close to the archival research approach of focusing on the firms that are already present in the country). (go back)

[9]  Abuaf (2015) and Bekaert et al. (2014) are examples of recent papers linking hurdle rates to political risk. (go back)

[10]  As a robustness check, we also estimated each of the regressions without the control variables. The magnitude and statistical significance of the risk aversion variable is robust to this alternative specification. (go back)

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What is political risk and how to protect against it? 

In today’s increasingly interconnected world, “just-in-time” supply chains, global internet connection and smartphones give SMEs the ability to conduct business in a global arena that was once the exclusive province of big multinationals. This means the possibility for great opportunities, but also that every business is just a few steps away from political risk .

Pierre Lamourelle, Deputy Global Head of Specialty Credit within Allianz Trade for Multinationals – our team dedicated to multinationals – answers the question “What is political risk?” and provides information about political risk management, explaining how political risk insurance can help protect your company.

What is political risk in business?

Political risk is the possibility that your business could suffer because of instability or political changes in a country : conflicts and unrest, changes in regime or government, changes in international policies or relations between countries, as well as changes that occur in a country's policies, business laws or investment regulations.

Other influential factors contributing to political risk include any other situation which may have an influence on a country’s economy, such as commodity price volatility, liquidity crises and sectoral downturns. Think of conflicts in the Middle East, the Arab Spring recurrent coups, confiscation of assets by local governments, and disputes over natural resources among nations. These may sound like unique political risks to international business, but they can still affect your local business and you may not see them coming.

“When it comes to political risk, we say it could be defined to a certain extent by its unpredictability ,” says Pierre Lamourelle , Deputy Global Head of Specialty Credit within Allianz Trade for Multinationals and a 25-year veteran of political risk assessment and management. “Contrary to most other types of insurance, it’s not always possible to model this type of risk based on historic data.”

Types of political risk 

War, terrorism, and civil unrest , unilateral decision made by a state-owned entity, geopolitical decisions made by governments, jurisdictional risk.

Jurisdictional risk is also a major political risk in international business, whether your company is an SME looking to expand or a global multi-billion-dollar company. “Jurisdiction” refers to the laws that will govern the agreement you sign with your partner . When that partner is in another country, difficulties can arise should the terms of the contract begin to unravel.

For instance, a European company contracting with an African company under local law would not be exposed to the same legal framework as it would under English or French law or if the contract is subject to international arbitration for the resolution of disputes between the parties. “If you chose the local law, you could be exposed to unexpected changes in the local law regulation or difficulty to enforce a decision made by a local tribunal ,” Pierre points out. “The choice of the law governing the commercial contract is often the responsibility of the insured and is not an insurable risk as such. However, it is worth mentioning that non-respect of an international arbitration award can be included as a cause of loss, and therefore could be covered under certain political risk insurance policies.”

Having the knowledge of how to deal with the complexity of the local legal environment can make a big difference in your ability to withstand and manage political risks. International risk insurers such as Allianz Trade have people on the ground in more than 40 countries dealing with political risks of all types: check out our political risk map .

How political risk can affect your business

“What has changed in the 25 years since I started in this business is that we are living in a more connected world today,” says Pierre. On the upside, that means business is easier to conduct on a global scale . Almost everybody now has the ability to reach out to emerging countries or to conclude a contract and to secure a sale in a foreign country.

On the downside, this means that when something goes wrong in one part of the world, you can feel the impact halfway around the globe – directly, if you are dealing with the country in question, or indirectly because of your diverse supply chain. Remember when the 20,000-tonne container ship “Ever Given” got stuck in the Suez Canal in March 2021, shutting down international trade for a week?

Another good example is when your own government decides to ban sending people on the ground to the country where you are executing your contract. “You would have to stop the performance of your contract,” says Pierre, “and you would be exposed to additional expenses and not be able to keep on performing or to keep invoicing and receiving payment from the customer in that specific country. This ban would clearly translate into a loss for the contractor.” 

As a last illustration, let’s take a change of law or a regulation that is super-selective and targets only foreign companies. “That could be seen as a soft discriminatory measure and could be covered as a political risk,” says Pierre. “But only if it’s a discriminatory measure. Any governmental decision that would impact all the companies located in a country is not captured by a political risk insurance policy. These are risks that all business owners are facing when running a business.”

Political risk management is essential in these situations in order to assess the risks and define actions to protect your company.

Political risk management

Some risks may be worth taking for the exposure to new markets at opportune moments. But it is always important to keep your eyes and ears open because political risks in international business aren't always well-identified . Sometimes the risks may be just rumours – events that one could deem as not material with little or no substance behind them.

Some of the early signs of political risk are political, economic and social instability:

• The political situation in the country: how is the country behaving with its neighbours? You want to be prepared if there’s an escalation of tensions or a war.
• The economic conditions: what are the macro-economic imbalances? How stable is the economy? What is the ability of the country to honour its payment obligations or debt over the period of your project? 
• The social conditions: is youth unemployment or underemployment high (think: Arab Spring, Sudan, Algeria etc.)? Are social tensions erupting into violence? Riots can also impact trade transactions or performance of commercial contracts. For example, there is a strong correlation in countries whose economies are heavily dependent on natural resources such as oil and gas. “You know that in these countries if the price goes below a certain threshold, there are going to be fewer resources to finance social programs and that can lead to some social instability or even the inability to honour debt obligations,” Pierre points out. 

Do you need political risk insurance?

Political risk insurance is not a “mandatory” insurance product. It is a niche market, originally used by large exporters, international contractors or banks facing the risk of contract interruption, or the risk of non-payment  or non-repayment of a loan. However, political risk is no longer the exclusive domain of emerging countries . It can directly impact all businesses due to the increased interconnection of economies. Political risk insurance, targeted to your specific engagements by an insurer with a global reach, can secure your economic and business interests . 

“For companies, political risk insurance can cover, for example, non-payment of a cargo or the non-performance of a contract,” explains Pierre. “ When it comes to banks, we cover their full spectrum of transactions from export finance to trade finance, to infrastructure finance, asset-based finance and structure-trade finance. So, it’s a highly-customised solution.”

What about recovery? “The destruction of an asset… there’s no recovery potential for that,” says Pierre, “but if you insure against non-payment or non-reimbursement by a state or local government entity, you have the ability to make a claim against the government and get recoveries .” Or the debt may be rescheduled.

Credit and political risk insurance: what’s the difference?

Trade credit and political risk insurance (or structured trade credit insurance) are not mutually exclusive, they are compatible . Trade credit insurance  covers risks to your company’s short-term portfolio of receivables. Structured trade credit or political risk insurance covers a specific transaction, with risk horizons that can vary from very short-term risks to long-term ones. Trade credit and political risk insurance, therefore, go hand-in-hand to secure your business transactions .

“We design the political risk insurance policy transaction by transaction, for a specific loan for a specific contract,” explains Pierre. “Discuss with your insurer or specialised broker and check where you are really exposed and whether there is a need for political risk cover.”

As a conclusion, Pierre reflects on his 25 years in risk management and points out: “You can have a very strong transaction in a very complicated and sensitive country, but you could also have a very bad transaction – if it’s not well structured – in a developed country. I’ve seen lots of transactions performing very well in emerging economies, and conversely claims that have been made on supposedly strong counterparties."

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5 Strategies for Mitigating Political Risk

by Lydia Stowe, FiscalNote

Political risk management is vital to operating in different regions or countries. Here are five effective strategies for effective political risk mitigation.

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Increasingly, nearly every industry is deeply impacted by geopolitical events that might have seemed distant in the past. Organizations that may not have paid attention before are forced to do so now, or risk being caught off guard by disruptions that threaten their business. For example, China’s zero-Covid policy has impacted the supply chain even for national and local organizations, such as home builders or car dealerships. Similarly, landmark decisions by the U.S. Supreme Court around abortion and gun rights have had an impact even for organizations outside of the areas directly hit by these decisions — either because of public pressure or while trying to keep their unrelated issues front and center with legislators.

As organizations realize that political events around the world can have a major impact on their business, mitigating political risk is becoming a pressing task. Political risk management allows you to stay on top of policies that could be detrimental and identify and seize opportunities for your organization. Here are the top strategies to keep in mind.

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What is Political Risk?

Political risk is the possibility that your organization could suffer because of political events on a national or global scale, such as an armed conflict , constitutional referendum , election , or major policy developments . Changes in legislation or policies can also present a political risk for an organization.

There are two types of political risk: macro and micro risk. A macro risk is a threat to a country’s economic or government environment, impacting entire industries. A micro political risk has smaller-scale impacts and might threaten only an individual organization. However, the effects of a micro political risk can be just as damaging to your organization as a macro risk.

Global or multinational companies may be more likely to encounter more political risk, but increasingly, monitoring and navigating policies and politics around the world is becoming more important for organizations of all shapes and sizes. Events in the last several years have sent many teams scrambling to keep up and find a way to monitor global political risk, and this trend shows no signs of abating: 25 percent of government affairs professionals expect global legislation and regulation to have a bigger impact on their organization over the next five years, a FiscalNote report found .

Political Risk Mitigation: Key Strategies

Using these political risk management strategies can safeguard your organization and save time, money, and prevent devastating business impacts. Here are five fundamental strategies to mitigate political risk:

Risk analysis. It is vital to research and analyze the local infrastructure of a region before investing.

Consult with local partners. Make connections with local organizations to better understand the market, local political system, and specific risks.

Local banking. Employ local banks in the region where you’re conducting business to mitigate financial and political risk.

Political risk insurance. Purchase insurance to protect your organization’s assets.

Monitor global issues. Proactively stay up-to-date on local issues and policies to plan and prepare for potential risks.

Risk analysis is ongoing, not a one-time transaction. If you want to be ahead of the curve, a company's considerations of the global political climate must be constantly evolving. Erica Stieper , Manager, Professional Services FiscalNote

1. Risk Analysis

Researching and analyzing the local infrastructure of a potential region for planned investment before actually investing is a key strategy to mitigate political risk. Factor in the local political climate, recent history, and experts’ projections for the future. It’s also necessary to weigh the potential benefits against the likelihood of loss if legal issues or political turmoil arise.

Risk analysis should extend to the full spectrum of macro risks: geopolitical, markets, policy, economic, regulatory, social, environmental, security, and reputational, as well as issues on a micro risk level that could impact your organization.

“Risk analysis is ongoing, not a one-time transaction,” says Erica Stieper, manager of Professional Services at FiscalNote. “If you want to be ahead of the curve, a company's considerations of the global political climate must be constantly evolving.”

Rather than conducting risk analysis alone, it is beneficial to hire specialists in political risk management analysis. These advisors can provide a personalized understanding of the external risks and challenges facing your organization and enhance your political risk management strategy.

A consultant “gives an understanding of how to manage different priorities or risk situations in particular parts of the world,” Stieper says. “They can distill complex issues that differ across industries, countries, and regions, keeping track of and filtering sanctions, legislation, and regulation to help companies understand the threats and opportunities to come.”

2. Consult with Local Partners

Partnerships with local companies and leaders are invaluable in your political risk mitigation strategy. Making connections within a local market allows your organization to better understand the market, its local political system, and specific risks. “You’re making a positive investment in a region with the people you employ, the income you bring in, and imports and exports,” Stieper says. “You want to partner with community leaders to show them the value of collaboration. The more you connect, the more opportunities open up.”

Team up with local businesses, research and professional trade organizations, local governments, and political leaders to get “boots on the ground” intel and gain a deeper awareness of a region. This allows you to understand a region’s struggles, have stakeholders to advocate for you, and get locals on your team.

“Connecting with international colleagues who reside in your key markets is a great initial step toward understanding not only the region’s priorities but also the potential implications in your home market,” says Yvette Williams , senior manager of political programs and grassroots advocacy at Johnson & Johnson. “Extending an invitation for a virtual introductory conversation with an overseas colleague is a quick and easy step to making those connections.”

3. Local Banking

Using local banks, or a bank with branches or connections in the region where you’re conducting business, is an often-overlooked way to mitigate political risk. While local banking can seem like a hassle (and may not always be possible), it minimizes financial, and therefore political, risk and is an opportunity every organization should look into.

As you consider financial risk, “think about tax rates, government stability, and exchange rate fluctuations and whether it’s beneficial to do business there based on that,” Stieper recommends. During times of political crisis, the winning combination of local partners and local banking keeps your organization protected and in the know.

4. Political Risk Insurance

Purchasing political risk insurance is an important way to protect your organization and investors financially. This insurance protects against political actions that would cause your organization to experience a major financial loss. Having this insurance can offer peace of mind when your organization looks to expand into developing countries since it will incur less risk if the region faces political instability.

There are many places to purchase political risk insurance, so shop around and find the plan that is tailored to your organization’s needs. Your political risk insurance plan should cover the countries in which your organization operates and ideally be locked in for many years as political landscapes can change quickly.

5. Monitor Global Issues

Today, change happens faster than ever — and it can be broad, unclear, and difficult to deal with. From the ongoing global pandemic and its health, trade, and economic fallout to cybersecurity breaches and geopolitical upheavals, mitigating risk and identifying opportunities can be a mission impossible... unless you have the right tools in place.

Traditional approaches to monitoring global issues are too fragmented, so it’s crucial to rely on data and expert analysis, manage stakeholders, and drive cross-departmental coordination through dedicated issues management software . Monitoring global issues is a proactive strategy that keeps your organization updated at all levels of government and markets, and therefore potential risks, to plan and prepare for the future.

FiscalNote ’s solutions allow you to proactively identify, monitor, and mitigate threats. Combining AI capabilities, expert analysis, business intelligence, and regulatory and geopolitical data, we provide you with the leading geopolitical, macroeconomic, and industry intelligence to navigate complex markets and inform critical decisions.

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Managing Risk in an Unstable World

• Ian Bremmer

As emerging markets generate greater shares of global supply and demand, companies need better methods to weigh political risk against financial reward.

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With emerging markets like China and politically unstable countries like Saudi Arabia figuring more than ever into companies’ investment calculations, business leaders are turning to political risk analysis to measure the impact of politics on potential markets, minimize risks, and make the most of global opportunities. But political risk is more subjective than its economic counterpart. It is influenced by the passage of laws, the foibles of government leaders, and the rise of popular movements. So corporate leaders must grapple not just with broad, easily observable trends but also with nuances of society and even quirks of personality. And those hard-to-quantify factors must constantly be pieced together into an ongoing narrative within historical and regional contexts.

As goods, services, information, ideas, and people cross borders today with unprecedented velocity, corporations debating operational or infrastructural investments abroad increasingly need objective, rigorous assessments. One tool for measuring and presenting stability data, for example, incorporates 20 composite indicators of risk in emerging markets and scores risk variables according to both their structural and their temporal components. The indicators are then organized into four equally weighted subcategories whose ratings are aggregated into a single stability score. Countries are ranked on a scale of zero (a failed state) to 100 (a fully institutionalized, stable democracy).

Companies can buy political risk analyses from consultants or, as some large energy and financial services organizations have done, develop them in-house. Either way, a complete and accurate picture of any country’s risk requires analysts with strong reportorial skills; timely, accurate data on a variety of social and political trends; and a framework for evaluating the impact of individual risks on stability.

The Idea in Brief

To navigate globalization’s choppy waters, every business leader analyzes economic risk when considering overseas investments. But do you also look beyond reassuring data about per-capita income or economic growth—to assess the political risk of doing business in particular countries? If not, you may get blindsided when political forces reshape markets in unexpected ways. Iran’s parliament, for instance, passed legislation in 2004 complicating foreign companies’ ability to plant stakes in that country’s telecom sector.

Appraising the myriad shifting political influences on your global investments isn’t easy—because political risk is hard to quantify. For example, how do you measure the impact of a national leader’s personality quirks on his country’s economic landscape?

Your strategy? In addition to analyzing economic risk, assess the four dimensions of political risk: Examine the stability and strength of government in nations where you’re exposed. Assess social trends such as growing income gaps and unemployment levels. Evaluate security by discerning how prepared a country is for natural disasters. And consider economic factors , such as a nation’s debt and openness to foreign investment.

By blending political and economic risk analysis, you make savvier investment decisions—seizing valuable opportunities around the globe while avoiding danger zones.

The Idea in Practice

To minimize risk in your overseas investments, assess the following dimensions of political risk:

How strong are the government and the rule of law? Early in 2005, for example, Turkey’s government was powerful and cohesive, and had gained popularity thanks to economic recovery and the European Union’s decision to open membership talks to Turkey. These developments indicate a relatively high level of political stability.

Also consider the level of corruption in government. You’ll need proxy metrics: For example, to evaluate the integrity of a country’s judiciary, ask, Are judges paid a living wage? Do programs exist to inform them about new legislation? Are judges often targeted for assassination?

How much social tension exists? How disaffected are the nation’s youth? How secure do individuals feel? To find clues, study the percentage of children who regularly attend school. Compare police and military salaries relative to criminal income opportunities. Assess young people’s access to medical care, unemployment rates, and imprisonment rates.

Persistent or widening socioeconomic inequalities—such as those in Turkey—can also signal possible social unrest leading to political instability.

How stable are the country’s geopolitical alliances? How prepared is the nation for emergencies, natural disasters, and internal strife? Example: 

Turkey’s security has come into question, owing to the continued presence of Kurdistan Workers’ Party militants in northern Iraq. The Turkish government worries that Kurds—empowered by the Iraqi elections—may seek to regain control of the oil-rich northern Iraqi town of Kirkuk. This could provide the financial basis for an independent Kurdish state near Turkey’s border—which in turn could fan separatist flames in Turkey’s own Kurdish population. Turkey’s concerns over growing Kurdish strength in Iraq have also strained its traditionally close ties with the United States—suggesting potential obstacles to American investments in that country.

What are the country’s fiscal position, growth and investment, and debt? How economically open is the country? Does its political openness match its economic openness? If not, instability may ensue. Example: 

Economically, China is opening rapidly—as diplomats and negotiators globe trot in search of new trade relationships to feed the country’s growth. But China is still politically closed: This police state exerts absolute control over public expression. It’s also marked by corruption and inefficiency. Simultaneously, reforms are straining relationships between national and regional leaders, increasing the probability of an economic shock—followed by a political one.

Countries in turmoil elbow one another off the front page at a dizzying pace: Lebanon follows Ukraine follows Sudan follows Argentina. Companies, meanwhile, fear unpredictable change, even as they seek profit from the opportunities change creates—a freshly privatized industry in Turkey, recently tendered oil blocks in Libya, a new pro-Western government in the former Soviet republic of Ukraine. To help weigh dangers against opportunities, corporations mulling foreign ventures routinely consult economic risk analysts. But basing global investment decisions on economic data without understanding the political context is like basing nutrition decisions on calorie counts without examining the list of ingredients.

• IB Ian Bremmer is the president of Eurasia Group and author of Every Nation for Itself: Winners and Losers in a G-Zero World . He is also a member of the World Economic Forum’s Global Agenda Council on Geopolitical Risk .

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Understanding and Managing Political Risk

An International Investor Guide to Political Risk

Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest.

What Is Political Risk?

The impact of political risk, managing political risk, watch for the indicators, frequently asked questions (faqs).

 Jonathan Rashad / Getty Images

International investing is a powerful way to diversify and grow a portfolio. However, there is often a higher level of risk than in domestic investing. Many of these risks are unique to international investing and can be caused by conflicts, unrest, changes in international policies between countries, and internal politics.

Political risk is among the most important factors facing international investors. In many emerging and frontier markets, the political situation is affected by more than influences within the country being considered. Conflicts in the Middle East, Chinese debt problems, American policies, and disputes over resources around the globe directly affect international investment opportunities.

Political risks are risks associated with changes that occur within a country's policies, business laws, or investment regulations. Other influential factors include international relationships and any other situation which may have an influence on the economy of a given country.

A common example of political risk is countries that are in political upheaval. Many countries are experiencing changes in social attitudes and perspectives as of late, causing unrest, changes in politics, and political movements that are disrupting economies.

Relatively new to the scene of political risk is technology. The rise in cell phone ownership allows everyone with a phone to be a photographer, journalist, or source of information. Confidence in investments, companies, and countries can be shattered within a matter of seconds of a video being posted online.

It's important to note that political risks aren't always well-defined—in many cases, the risks may be rumors with little or no substance behind them. International investors must, therefore, keep an eye on the news rather than just looking at just performance data to manage these risks.

A rise in political risk has a variety of impacts on a country and companies operating within its borders. While the most noticeable impact is a decline in equity prices, many countries facing higher political risk factors experience reduced foreign direct investment (FDI), which can prove destabilizing.

A reduction in FDI can lead to slower economic growth across the board, as well as potential social issues. Social issues, such as wage gaps, inequality, and corruption, can lower the value of international equities.

These issues may also affect other asset classes. For example, sudden slower economic growth could impact a country or company's ability to repay its debts, which could impact the bond markets.

Slower economic growth or a crisis could also prompt currency-related issues . A decline in a country's currency value could, in turn, lead to slower exports and reduced economic growth.

The first step in managing political risk is understanding that these risks are often worth taking in order to maintain a diversified portfolio. Even if you keep all of your investments in the U.S., you are still exposed to decisions made in Washington D.C.

Investors should maintain a diversified portfolio in order to avoid any specific political risk significantly impacting the overall portfolio. Diversification should include hedging the risk that is inherent to international investments.

International investors can manage risk by hedging their portfolio against future problems. For instance, an investor that senses problems arising in Brazil might decide to buy put options (the option to sell at a set price) on the iShares MSCI Brazil Index ETF (NYSE Arca: EWZ). If your put option is placed at the right value, you could significantly reduce your losses if the index were to fall or create gains elsewhere in your portfolio.

You should monitor your international investments for potential political risks. The CIA World Factbook is a great place to start with a wealth of background information on a country’s government, politics, and economy.

Some indicators to watch out for in the countries you may invest in are the rise of different or new political parties, upcoming elections, or any new trade agreements affecting a country. It may also be helpful to set up alerts or other automated reminders to keep track of potential political risks in key markets.

This way, you can be alerted early on when problems arise, and then take the necessary actions to reduce exposure to riskier areas. The key is to not overreact to the news but to determine what's truly happening and if it impacts your investments.

What are the two types of political risk facing international companies?

Companies that conduct international business may differentiate between macro and micro political risks. A macro risk threatens the country's economic environment more broadly, while a micro political risk might only threaten a single firm. Changes in monetary policy are examples of macro risk. A labor strike over differences in working cultures could be an example of micro risk.

How do you measure political risk?

Measuring political risk isn't an exact science for all economists, but several have attempted to quantify it. " Political risk spreads " are one measurement that economists have come up with that includes factors such as bond liquidity and other country-specific economic indicators. Other economists have worked on firm-level calculations to estimate a company's political risk.

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How Companies Can Navigate Political Risks Successfully

June 8, 2021 • 12 min read.

Companies are facing heightened political risks across the globe but are mostly unprepared to handle them. A new EY-Wharton Political Risk Lab study offers firms guidance on how to manage these risks more proactively.

Companies are facing heightened political risks across the globe, but the majority of them are underprepared, reactive, and lacking confidence in their ability to navigate those risks successfully. Geopolitical risks are the biggest, especially with COVID-19 disrupting supply chains, the rise of nationalization and protectionism, the hardening of U.S.-China trade tensions, and increasing confrontations with authoritarian regimes that provoke cycles of sanctions and retaliatory actions.

Those are some of the main takeaways from a study released last Friday conducted by the Wharton Political Risk Lab in partnership with its inaugural sponsor, EY-Parthenon’s Geostrategic Business Group. Titled Geostrategy in Practice 2021 , the study is the second in an annual series (last year’s report is available here ). The study identifies five steps for companies to manage their political risks more proactively and strategically:

• Identify and collect quantitative political risk indicators.
• Develop or acquire the ability to assess the business impact of political risk.
• Integrate political risk into enterprise-wide processes.
• Engage the board and C-suite to incorporate political risk into strategic planning.
• Set up a cross-functional geostrategic committee.

The study was based on a survey of more than a thousand C-level executives, a quarter of whom were CEOs. Half of the respondents represented corporations with more than $5 billion in revenue. Survey respondents were based roughly equally across the Americas; Europe, the Middle East and Africa; and Asia-Pacific. The study covered seven industries – advanced manufacturing and mobility; consumer products; energy and resources; financial services; health sciences and wellness; real estate, hospitality and construction; and technology, media and telecommunications.

Globalization: The Biggest Casualty

The overarching risk is to globalization, which will force companies to revisit their strategies and valuation models, according to Wharton management professor Witold Henisz. Henisz is director of the Political Risk Lab and helped design the study, and he personally conducted nearly 50 hourlong interviews with senior executives. “The biggest concern was that companies have to have a China-centered supply chain and a non-China-centered supply chain,” he said.

“For many industries that have worked in the last 20 to 30 years to integrate their supply chains, that may not be possible anymore,” Henisz explained. “Companies are starting to think about supply chain resilience and, in particular, developing parallel supply chains to support growth in the Chinese market and the rest of the world, which is creating enormous costs and redundancy, especially for some industries that are heavily dependent upon Chinese suppliers.” Those concerns are most pronounced in electronics, telecommunications and rare earth metals, he added. “For several industries, there isn’t a clear existing alternative and companies start to think about how to rebuild their supply chain or reconstitute a non-Chinese supply chain.”

“The coronavirus pandemic exposes and accelerates the materiality of these external risks to levels not seen for perhaps 90 years,” Henisz said in a video on the biggest impacts the study identified. It also lays bare the manner in which firms prioritize short-term shareholder interests relative to stakeholders, which will influence the political risks that they face in the future. “The decisions that firms make today about how to treat their workers, suppliers, buyers, and communities will be remembered by these stakeholders once the crisis has eased and as a result will help shape our collective post-crisis future.”

“We’re seeing political risk increasing, but the confidence and the ability to manage risk is decreasing.” –Witold Henisz

The study revealed the degree to which political risk management at companies is broken. Ninety-four percent of respondents said unexpected political risk is increasing in its impact on their companies. “That’s dramatic — the fact that political risk is not stable, and that it will continue increasing is a powerful finding,” Henisz said. Only 55% of the respondents said they were confident in their ability to manage political risk in the latest survey, significantly lower than the 74% who expressed that confidence in last year’s survey. “We’re seeing political risk increasing, but the confidence and the ability to manage risk is decreasing.”

Most companies agreed on the types of political risks they face. “We were somewhat surprised that there wasn’t more industry or regional heterogeneity,” said Henisz. “It’s certainly true that if you extract oil, gas, infrastructure, banking, telecom, there was a greater perception of risk or greater impact. But even in consumer goods, and in industries that were very local and [a commodity industry like] agriculture, companies are struggling with exactly the same issues.”

For sure, companies are responding to the increased risks — nearly 70% of executives said their companies have significantly changed political risk management approaches in the past year. The majority of respondents (40%) said their companies have an ad hoc or reactive approach to political risk management, and about 29% of respondents said their companies are proactive on that front; the rest had a mixed approach or take only limited actions to manage political risk.

“Risk identification systems are not fit for purpose,” the study noted. “Most companies are pretty good at monitoring risks, and they rely on a combination of human intelligence and quantitative data,” said Henisz. They gather such information from internal staff or consultants, and increasingly tap quantitative risk service providers that use AI tools like natural language processing to extract insights from news and social media.

“The biggest gap is turning that data into value at risk or value at stake by quantifying the value of political risks,” said Henisz. “How is it going to impact revenue? How is it going to impact productivity? How is it going to impact operational efficiency? The gap is in connecting events to a forecast of financial impacts. They don’t connect the dots in political risk – that’s where I think the biggest opportunity is.”

Many companies relegate their political risk management to a public affairs or government affairs function, but that tends to operate in a silo without involving different functions across the company or local-level executives such as country managers, Henisz noted. That underscores the importance of a governance structure that combines qualitative insights with quantitative financial impacts, he added.

Data as a Political Tool

One of the novel and underappreciated threats companies face is of risks around data security and privacy. Henisz pointed to a recent New York Times investigative report on how China forces Apple to store the personal data of its Chinese consumers in data centers the Chinese government has access to. Two years ago during the anti-government protests in Hong Kong, Apple removed an app from its App Store that helped protesters track the police, after it faced intense pressure from the Chinese state media. Governments have control over data of multinational companies in other “authoritarian countries” including Russia and Turkey , he added. The European Union imposes constraints on MNCs that may want to transfer their data outside the EU to their parent organizations in the U.S. or elsewhere.

“Data is becoming increasingly politicized and is being used as a political tool,” Henisz said. “More and more executives are talking about it, but it isn’t on top of people’s minds that politics and data are connecting in a new way.”

“Data is becoming increasingly politicized and is being used as a political tool.” –Witold Henisz

In some instances, companies face political risks at both ends of the spectrum. In recent months, Western fashion brands including Nike, H&M and Burberry have faced social media attacks and boycott calls in China for taking a stance on alleged human rights abuses of the Uyghur Muslims in the Xinjiang region of northwest China. In other settings such as during the Hong Kong protests, the Chinese government urged companies to speak up in favor of its policies.

Sometimes companies have to make hard choices over tensions that affect their employees and their customers, said Henisz. “Between the Hong Kong protests and the Chinese suppression of the Uyghur minority, companies are under enormous pressure not to speak out in a way that is inimical or contrary to Communist Party interests, and many companies tried desperately to stay off that,” Henisz said. “But as the companies were trying to lay low, the Chinese government was pressuring them to say … that they don’t support Hong Kong rights, and that they support the One-China policy. Companies are increasingly struggling to navigate that.”

In some instances, companies find themselves damned if they are compliant with a government directive and damned if they are not. Swedish retailer H&M recently changed a map on its website to match China’s territorial claims in the South China Sea, but faced a social media backlash in Vietnam , which opposes China’s claims in the region. “There are similar pressures in Turkey, Brazil, Russia and other countries to demonstrate fealty or loyalty to a nationalist regime,” said Henisz. “Some of that was reflected in the U.S. under the Trump administration as well. So that tension between being a global company and being seen as sufficiently national or sufficiently loyal is a struggle that many companies are facing.”

“[Similarly] in India, multinationals and Indian corporations have not been vocal about the suppression of voting rights of the Muslim minorities in India,” said Henisz. “These are the pressures that companies face to comply with the priorities of political leadership. At the same time, there are demands from NGOs, human rights activists and employees to say something, to show that these are issues of concern for them. And companies are increasingly stuck in the middle.”

Fruits of Being Proactive

Some companies that are proactive in their political risk management have avoided the consequences they would have otherwise faced. Drawing from his prior research, Henisz pointed to mining company Anglo American and energy producer Chevron’s operations in Nigeria as examples of preparedness.

Learning from its previous mistakes, Anglo American developed a so-called Socio-Economic Assessment Toolbox , or SEAT, which is a way of assessing the political environment in a given country or region before embarking on a mining project, he said. “Before they start mining, they might spend a year or two understanding the political and social environment, having anthropologists and others map out the web of relationships and issues, because they know that, absent that understanding, they can never have a successful mine,” he added. “It may cause them maybe to go a little bit slower and to spend a little bit more money up front. And they haven’t been perfect. There have been cases of failure and cases of incomplete implementation. But they have among the best systems that I’ve seen at the corporate level to navigate this.”

Chevron had faced violence in Nigeria and nearly shut down its operations in that country before it developed a regional strategy that involved stakeholders across government, local businesses, and jobseekers. “They transformed the way they were working with stakeholders in Nigeria in a way that was much more farsighted,” said Henisz. The company in 2014 formed what it calls the Niger Delta Partnership Initiative , which adopted an overall approach instead of striking one-off deals with local leaders. “It’s not perfect, and there have been problems. But the redesigned approach led to a reduction of the conflict that they’ve faced. They have been able to resume operations and have less violence and less loss of oil than other oil companies in Nigeria.”

“The solution doesn’t sit in headquarters. It sometimes sits in this country or in this function, and [companies] need to make sure that gets shared back.” –Witold Henisz

Common Missteps

According to Henisz, a common misstep at companies is in avoiding involvement from people across different functions under the assumption that somebody at the top has to control the firm’s political risk management strategy. “Whenever there’s a perception of arrogance or of being a top-down imposed system, there’s resistance,” he said.

“The companies that succeeded asked right from the beginning: ‘How could [our geostrategic function] be valuable to you? What do you need? What would be important? How could this structure help you?’” Henisz continued. “As they were building it, they were doing as much listening as talking. It was much more of a collaborative design that involved people from different geographies and different functions. The solution doesn’t sit in headquarters. It sometimes sits in this country or in this function, and they need to make sure that gets shared back.”

Being proactive rather than bribing their way out of a difficult situation is another insight Henisz gained from his previous research on political risk management. “There is a way of doing business that involves envelopes given to well-connected political insiders,” he said. A well-designed governance structure could help companies avoid that route, he noted. “We’re talking about early on shifting your contracting, your sourcing, your operations and everything else so that you solve the political problems of the people who might otherwise put up a barrier. You’re aware of them earlier. You deal with them through your business operations, not through cash in an envelope.”

Jobs are usually a source of tension for MNCs setting up new projects, Henisz noted. Proactive approaches would be to ensure up front that the jobs do not go to people of any one ethnicity or other category and thus avoid resentment building up, he said. “What if from the beginning you split the jobs in a way that was perceived as fair? And what if you explained that that was part of the way you viewed good business in this country?” he asked. “We can think about similar issues in the U.S. with the Black Lives Matter movement and racial justice. Political risk is very closely and centrally tied to your reputation.”

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What Is Political Risk: How to Control and Mitigate It in Your Business Strategy

An Explanation of Political Risk and Its Significance in Business Operations

Political risk refers to the possibility of financial or operational losses arising from political change and regulatory changes or events in a particular country. These events can include changes in government policies, political instability, social unrest, terrorism, or war.

Political instability or uncertainty can make it difficult for companies to plan and invest long-term. It can increase costs, delays, and disruptions in supply chains and distribution networks.

Companies may also face restrictions or penalties for non-compliance with new regulations or changes in tax, labour, or environmental regulations.

In some cases, political risk can physically damage a company’s assets or employees. This can include riots, civil unrest, or terrorist attacks. Companies operating in politically risky environments may also face reputational damage, loss of market share, or adverse publicity, which can impact their financial performance.

Given the potential impact of political risk on international business operations, companies must take steps to assess and manage political risk. This can include implementing risk management strategies , contingency planning, and diversifying their operations across multiple countries or regions. By doing so, companies can minimise the impact of political risk on their operations and ensure their long-term viability.

The Importance of Controlling and Mitigating Political Risk

Managing political risk is crucial for businesses to ensure long-term sustainability and profitability. Here are some of the reasons why:

• Protecting business operations: political risk can disrupt a company’s operations, resulting in losses of revenue, increased costs, or reputational damage
• Improving predictability: political risk can create uncertainty in the business environment, making it difficult for companies to predict future economic conditions or regulatory changes
• Enhancing stakeholder confidence: investors, customers, and other stakeholders place a premium on companies that can effectively manage political risk
• Gaining competitive advantage: managing political risk can also give companies a competitive advantage. Companies that can operate in risky environments or navigate complex political landscapes may be better positioned to gain market share or enter new markets where others cannot
• Ensuring business continuity: companies can better weather political shocks by developing contingency plans and risk management strategies to ensure the long-term viability

Political risk is inherent for a global business in today’s global economy.

By controlling and mitigating political risk, companies can protect their operations, improve predictability, enhance stakeholder confidence, gain a competitive advantage, and ensure long-term viability.

Understanding Political Risk

Types of political risk.

As discussed, political risk is the risk that political decisions, events, or conditions will impact a business or investment. It can arise from various sources, such as elections, political violence, war, and changes in host government policy. This section will discuss some examples of the different types of political risk:

• Sovereign risk: a government fails to meet its obligations, such as debt repayment or failing to provide expected services. Sovereign risk is a significant factor in investments in foreign countries, as investors must be aware of the country’s political and economic stability to protect their capital
• Systemic risk: a government’s decision or a policy change will affect the economy. This type of risk is usually caused by macroeconomic policy changes, such as changes in taxation or interest rates
• Regulatory risk: when a government action changes statutes or regulations
• Macroeconomic risk: such as changes in monetary or fiscal policy create economic instability
• Political instability risk: a country experiences political unrest, such as political demonstrations, strikes or coups
• Political violence risk: such as riots or civil war, will impact a business or investment. This type of risk can be caused by social unrest or political instability in a country
• Geopolitical risk: a government takes action that affects the geopolitical environment, such as engaging in a military activity or conducting diplomatic relations, which can affect investments
• Currency risk: a government takes action that affects the value of its currency, such as devaluing or revaluing the currency
• Exchange rate risk: a country’s exchange rate change will affect a business or investment. This type of risk can be caused by a variety of factors, such as changes in government policy or economic conditions
• Event risk: a political change or natural disaster will affect a business or investment. This type of risk is usually unpredictable

How Political Risk Differs From Other Types of Risk

Political risk differs from other types of risk because it arises from political and regulatory changes or events in a specific country or region rather than from market forces or economic cycles.

Here are some critical differences between political risk and other types of risk:

• Causes: arises from factors outside the company’s control, such as changes in government policies, social unrest, or terrorism. Different types of risk, such as market risk or credit risk, are generally caused by economic or financial factors
• Scope: can impact a company’s operations in a specific country or region, whereas other types of risk can affect a company’s operations globally. For example, a company may face political risk in one country due to changes in government policies while simultaneously facing market risk in another country due to a downturn in the global economy
• Predictability: often less predictable than other types of risk. Political events or regulatory changes can be sudden and unexpected, making it difficult for companies to plan and respond. On the other hand, other types of risk may be more predictable, based on historical trends or economic indicators
• Control and Mitigation: political risk is more challenging to control and mitigate than other types of risk. While companies can use risk management strategies to manage market or credit risk, the political risk may require more proactive measures such as building relationships with key stakeholders, monitoring political events and changes, and developing contingency plans

Companies operating in politically risky environments must be aware of these differences and proactively manage political risk to ensure long-term viability.

Assessing Political Risk

Factors Affecting Political Risk

Political risk is an inherent risk of conducting business in a foreign country or region, as the political environment in the country or region can significantly influence the amount of risk a company may face.

Political risk factors include the country or region’s political stability, government structure, and economic policies.

Political stability is the likelihood of a significant disruption or change in the country or region’s political landscape, such as a coup or a revolution.

Government structure and economic policies refer to the laws and regulations that govern the country or region and the fiscal and monetary policies that govern the economy.

The level of corruption in a country or region can also be a factor that affects political risk. Corrupt governments are often unpredictable and may be willing to take risks that other governments may not be willing to take. This can increase the risk of doing business in a country or region.

The geopolitical environment in a region can also affect political risk. Geopolitics studies the relationship between political power and geography, and geopolitical tensions can lead to regional instability. For example, suppose a country or region is located in an area with a high risk of war or political conflict. In that case, this can increase the risk of doing business in that region.

Finally, the socio-economic landscape of a country or region can also affect political risk. Socioeconomic factors such as poverty rates, education levels, and access to healthcare can all impact a country’s or region’s stability. They can increase the risk of doing business there. These factors can also lead to unrest and instability, increasing business risk in a country or region.

Tools and Methods for Assessing Political Risk

There are a variety of tools and methods available for assessing political risk. These include qualitative and quantitative analysis, scenario building, and risk mapping.

Qualitative analysis is conducted by analysing qualitative data such as public opinion polls, news reports, and interviews with industry experts. This analysis can help identify potential political risks and their likelihood of occurring.

Quantitative analysis involves using mathematical models and statistical techniques to assess the probability of potential political risks. This type of analysis can calculate the financial impact of a possible political risk.

Scenario building is a tool to assess the potential consequences of different political risks. This involves constructing a range of possible outcomes and their corresponding probabilities.

A political risk map is a tool used to evaluate the geographic spread of political risks. This involves creating a map of the world with regions identified as being at risk for political instability. This can help identify areas more or less vulnerable to risk.

Overall, these tools and methods help assess political risk and help to develop strategies to manage or mitigate the risks.

The Importance of Regular Risk Assessments

Navigating a constantly evolving political risk landscape can be arduous for businesses operating in unstable environments. Companies must conduct a regular political risk assessment to control and mitigate political risk. These assessments enable companies to stay informed and adjust their operations accordingly while identifying new and emerging risks that may impact their operations.

With the fluid nature of political risk, regular assessments help companies better to understand the likelihood and impact of different risks and to make informed decisions about where to focus their risk management efforts. Prioritising risks allows businesses to allocate their resources accordingly and develop contingency plans to minimise the impact on their operations.

Moreover, regular assessments demonstrate to stakeholders that the business is proactively managing political risk, thus improving the company’s reputation and attracting investors, customers, and partners. The dynamic nature of political risk means regular assessments are necessary to ensure that companies remain current on the latest trends and changes and make strategic decisions that protect their operations and assets.

To summarise, political risk assessments are essential for businesses operating in politically unstable environments. They enable companies to stay ahead of the curve, identify new risks, prioritise risk management efforts, and develop contingency plans. This, in turn, enhances stakeholder confidence and ensures the long-term viability of the business.

Managing Political Risk

The steps for managing political risk.

Managing political risk in a constantly evolving environment can be complex and challenging. However, by following these steps, businesses can effectively manage political risk and protect their operations and assets.

• Conduct due diligence: before entering new markets, businesses should conduct due diligence to assess political risk. This includes researching local political and regulatory environments and potential risks associated with specific locations or industries.
• Build relationships: Strong relationships with key stakeholders, such as government officials and local communities, can help businesses mitigate political risk. Companies can better navigate political environments by building trust and fostering open communication.
• Identify and assess risk: the next step is identifying and assessing the risks that may impact the business. This requires conducting regular assessments and staying informed about changes in government policies, social unrest, and terrorist activities.
• Develop risk management strategy: once risks have been identified, the next step is to develop a risk management strategy. This involves prioritising risks and allocating resources accordingly. Businesses should consider developing contingency plans to minimise the impact of political risk on their operations.
• Monitor and evaluate: political risk is constantly evolving, so monitoring and evaluating the risk management strategy is essential. This includes monitoring changes in government policies, social unrest, and terrorist activities and assessing the effectiveness of contingency plans and other risk management efforts.
• Stay informed: finally, staying informed about the latest trends and changes in political risk is essential for managing political risk. Businesses should stay up-to-date with the latest news, attend conferences and events, and network with other professionals in their industry to stay ahead of the curve.

Managing political risk is a complex and dynamic process.

Conducting due diligence, building relationships, identifying and assessing risk , developing a risk management strategy, monitoring and evaluating, and staying informed are all key to successful political risk management. Following these steps, businesses can effectively manage political risk and protect their operations, assets and people.

The Importance of Having a Contingency Plan

While businesses can take measures to manage political risk, having a contingency plan in place is crucial for mitigating the impact of unexpected events.

A contingency plan is a proactive approach to managing political risk that enables businesses to respond to sudden changes in the political environment quickly. The plan should outline specific actions that can be taken in the event of political instability, such as protests, strikes, or government policy changes.

The importance of having a contingency plan for managing political risk cannot be overstated.

Without a plan, businesses may be caught off guard by sudden changes in the political environment, resulting in lost revenue, damage to their reputation , and even legal or regulatory action. A contingency plan provides businesses with a roadmap for responding to political risk, allowing them to take immediate action to protect their operations, assets and people.

Furthermore, having a contingency plan demonstrates to stakeholders that the business is taking a proactive approach to managing political risk. This can enhance the company’s reputation and attract investors, customers, and partners who are more likely to do business with a company with a solid risk management plan .

In addition to outlining specific actions, a contingency plan should include a communication strategy to inform stakeholders of the company’s response to political risk. Clear and timely communication can help minimise the impact of risk on the business and ensure that stakeholders remain confident in the company’s ability to navigate the political environment.

How to Incorporate Political Risk Management Into a Business Strategy

Fostering a culture of risk management is a critical component of effectively managing political risk. This requires businesses to create an environment where employees feel empowered to identify and report potential risks . Employees should be trained and supported to help them develop the skills and knowledge necessary to assess political risk.

Identifying key decision-makers is another critical step. Businesses should identify individuals with authority to make crucial decisions that may impact the business. This includes executives, board members, and other senior leaders. By involving these decision-makers in the risk management process , companies can ensure that they are aware of potential risks and can make informed decisions about managing them.

As discussed, scenario planning is another powerful tool for managing political risk. Companies can identify potential risks and develop control and mitigation strategies by planning scenarios. This involves developing hypothetical scenarios that may impact the business and assessing the potential impact of each scenario. This can help companies to be better prepared for unexpected events and to make more informed decisions about how to respond to them.

Using data and analytics is also essential. Businesses should monitor political trends and changes and collect data on key risk indicators. These indicators can provide valuable insights into political risk and help companies make more informed decisions. By using data and analytics, businesses can better understand political risk and make more accurate predictions about future events.

Finally, collaborating with experts is an essential component of managing political risk. This includes working with consultants, analysts, and other professionals who deeply understand the political environment. By collaborating with experts, businesses can gain valuable insights and advice on managing political risk. This can help them to make more informed decisions and to be better prepared for unexpected events.

Controlling and Mitigating Political Risk

Strategies for Controlling and Mitigating Political Risk

Managing political risk is an ever-present reality for businesses operating in an international context. To control and mitigate these risks, companies should consider strategies such as:

• Establishing Political Risk Insurance (PRI): one of the most effective strategies for mitigating political risk. PRI helps to protect businesses from the financial losses associated with political events such as expropriation, currency inconvertibility, or contract repudiation
• Diversifying operations: companies can also reduce their political risk exposure by diversifying their operations across different countries and regions. This helps to spread the risk among a more significant number of markets and helps to mitigate the impact of any one political event
• Developing relationships: establishing relationships with political leaders and decision-makers is another way to reduce political risk. Companies can use these relationships to understand the political climate of a country better and to gain access to information that can help them to anticipate and mitigate potential risks
• Investing in risk mitigation programs: companies should invest in programs, such as political risk analysis and monitoring, to help identify and anticipate potential risks
• Implementing risk management strategies: companies should develop policies and procedures for responding to political events and should ensure that they comply with all relevant laws and regulations

These strategies can help to safeguard against potential financial losses due to political events.

The Importance of Diversification and Internationalisation

Diversification and internationalisation are key elements in effective political risk management. The ability to diversify risk across different geographies and markets is an invaluable tool to help reduce the volatility of political risk events.

Internationalisation allows companies to benefit from new markets, while diversification reduces the concentration of risk in one market.

Internationalisation can also provide access to resources and expertise and the potential to benefit from developing countries and the growth of emerging markets.

By diversifying, companies can spread their risk across multiple markets, reducing the potential impact of any one political event.

In addition, diversification and internationalisation can provide access to new customers and markets, which can benefit long-term growth and profitability.

Ultimately, diversification and internationalisation are essential components of an influential political risk management strategy, allowing companies to reduce the risk of political events and benefit from new markets and opportunities.

How to Minimise the Impact of Political Risk on Your Business

This section explores strategies companies can use to reduce their exposure to political risk and protect their investments, operations, assets and people from potential losses. From establishing a comprehensive risk management system to investing in political risk insurance, these strategies can help businesses navigate the political landscape and safeguard their operations.

• Develop a comprehensive understanding of the political landscape in which the business operates. Monitor changes in the political landscape and analyse their potential impact on your operations
• Establish a comprehensive risk management system that considers political risk. Develop contingency plans for different political scenarios
• Strengthen relationships with domestic and international stakeholders, such as government officials and political parties
• Invest in developing relationships with local communities, ensuring that the company’s operations are not seen as a threat to local interests
• Invest in research and development to develop innovative products and services that are more resilient to political risk
• Diversify operations across multiple countries and jurisdictions
• Increase transparency and accountability in reporting practices and business activities
• Create an effective response and contingency plan to deal with a potential political risk
• Maintain a good reputation with the public through effective communication and engaging in corporate social responsibility initiatives
• Invest in political risk insurance to protect against potential losses due to political risk

Final Thoughts

Political risk is a significant concern for businesses operating in unstable political environments.

It refers to the potential for political decisions or events to affect a company’s operations, assets, people or profits.

To effectively manage political risk, businesses should take a comprehensive approach that includes identifying potential risks, creating contingency plans, and integrating risk management into their decision-making processes. This should be supported by establishing a solid risk management culture , identifying key decision-makers, conducting scenario exercises, using data and analytics, contingency planning and collaborating with experts.

By taking these measures, businesses can make well-informed decisions safeguarding their operations, assets and people from political risk.

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• Government & Policy

How to Minimize Political Risk as a Multinational Company

How Do Multinational Companies Minimize Political Risk?

For multinational companies, political risk refers to the risk that a host country will make political decisions that prove to have adverse effects on corporate profits or goals.

Adverse political actions can range from very detrimental, such as widespread destruction due to revolution, to those of a more financial nature, such as the creation of laws that prevent the movement of capital.

Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policymakers, or military control. 

Key Takeaways

• For multinational companies, political risk refers to the risk that a host country will make political decisions that prove to have adverse effects on corporate profits or goals. 
• Adverse political actions come in a range, from events like widespread destruction due to revolution to financial changes like new laws that prevent the movement of capital.
• If a company enters an at-risk country, one solution is to purchase political risk insurance.
• Buying political risk insurance does not guarantee a company will receive compensation immediately after an adverse event.

The Two Types of Political Risk

In general, there are two types of political risk: macro risk and micro risk . Macro risk refers to adverse actions that will affect all foreign firms, such as expropriation or insurrection, whereas micro risk refers to adverse actions that will only affect a certain industrial sector or business, such as corruption and prejudicial actions against companies from foreign countries.

All in all, regardless of the type of political risk that a multinational corporation faces, companies usually will end up losing a lot of money if they are unprepared for these adverse situations.

For example, after Fidel Castro's government took control of Cuba in 1959, hundreds of millions of dollars worth of American-owned assets and companies were expropriated . Unfortunately, most, if not all, of these American companies had no recourse for getting any of that money back.

How to Minimize Exposure to Political Risk

So how can multinational companies minimize political risk? A couple measures can be taken even before making an investment.

The simplest solution is to research the riskiness of a country, either by paying for reports from consultants that specialize in making these assessments or doing research yourself using the many free sources available on the internet (such as the U.S. Department of State's background notes ). Then you will have the more informed option to not set up operations in countries considered political risk hot spots.

While that strategy can be effective for some companies, sometimes the prospect of entering a riskier country is so lucrative that it is worth taking a calculated risk. In those cases, companies can sometimes negotiate terms of compensation with the host country, so there would be a legal basis for recourse if something happens to disrupt the company's operations.

However, the problem with this solution is that the legal system in the host country may be substantially different from the company's country, and in some places, foreigners rarely win cases against a host country. Even worse, a revolution could spawn a new government that does not honor the actions of the previous government.

Buying Political Risk Insurance

If you do go ahead and enter a country considered at-risk, one of the better solutions is to purchase political risk insurance . Multinational companies could go to one of the many organizations that specialize in selling political risk insurance and purchase a policy that would compensate them if an adverse event occurred.

Because premium rates depend on the country, the industry, the number of risks insured, and other factors, the cost of doing business in one country may vary considerably compared to another.

However, buying political risk insurance does not guarantee that a company will receive compensation immediately after an adverse event. Certain conditions, such as trying other channels for recourse and the degree to which the business was affected, must be met. Ultimately, a company may have to wait for months before receiving any compensation.

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How Political Risks Arise in International Business Essay

Introduction, how political risks arise, mitigating political risks for international businesses.

Organisations that are involved in international businesses encounter myriads of risks in their process of exploiting global markets.

While establishing businesses in new markets, especially the emerging ones, the challenge of rejection of organisational cultures and policies, economic, and political risk emerges as a significant threat.

In 1959, the government of Fidel Castro took control of Cuba. During its tenure, assets worth millions of US dollars together with several US-owned companies were expropriated (Clark 1997).

While this situation led to immense losses, most of the organisations did not have strategies in place for recovering any of the lost money.

Learning from the Cuban political risks, the affected organisations began to develop strategies for mitigating losses that accrued from political risks while engaging in international businesses elsewhere.

Successful penetration and maintenance of international business depends on the capacity to mitigate the existing and the likely risks, particularly political risks.

A company that seeks to expand its sales potential, and hence its dominance in the international markets as a measure of gaining competitive advantage, must mainly focus on establishing new business operations in the emerging markets. Such markets have most of their potential unexploited by competitors (Rogman 2004).

While this move encompasses a major strategic decision to enhance both the short-term and long-term success for an international organisation, political risks form a major drawback in such markets (Rogman 2004).

For instance, planning to operate in the Middle Eastern nations requires assessment in addition to deriving strategies of dealing with risks resulting from political conflicts such as instabilities in Afghanistan, Iran, Iraq, the Israeli-Palestine conflict, and the Syrian conflict among others.

This paper discusses how political risks can arise for international businesses. It critically evaluates different mechanisms for mitigating such risks.

Political risks include the threats that nations in which organisations establish international operations make some decisions, which negatively reduce or severely influence its goals and/or profits.

The risks may range from destruction of the business of an organisation due to revolution and wars because of policies that hinder capital movement and other laws that negatively influence multinational organisations financially.

Ilan, Mitchell, Gurumoorthy, and Steen (2006) classify political risks into macro and micro risks. Macro risks, such as insurrection and expropriation, affect every firm that operates within a nation.

Conversely, Anderson (2009, p. 2) observes that micro risks entail, ‘adverse actions that only affect a certain industrial sector or business such as corruption and prejudicial actions against companies from foreign countries’.

Irrespective of the type of risk, political risks lead to immense financial losses for multinational organisations.

The classification of political risks into micro-level and macro-level risk factors implies that these risk factors give rise to international business risks. Micro-level risks influence a multinational business at project or industry levels.

For instance, in the Middle Eastern nations, while governments favour no tax-policies, the cost of telecommunications may out-power the rental costs of business premises (Rogman 2004).

Hence, organisations that are highly dependent on telecommunications services to conduct their businesses will encounter more telecommunication-associated risks in relation to other organisations that operate in different industries.

Although this policy may affect all organisations that operate in the Middle Eastern markets, industry-specific political risks favour the operations of local businesses in comparison with international businesses.

This observation occurs when local business owners possessing a large amount of political powers engage in nationalisation or expropriation of assets and projects (Hayes & Cummings 2001).

Macro-level political risks influence organisations that operate in all industries within a nation. However, this situation does not imply that the risks arise only at country levels.

Jeffrey (2004) reveals that regional, local, and national political events can have negative impacts on the operations of organisations in different nations within a particular region.

Macro-level political risks arise from ‘governments’ currency actions, regulatory changes, sovereign credit defaults, endemic corruption, war declarations, and government composition changes’ (Ilan, Mitchell, Gurumoorthy & Steen 2006, p.629).

These risks expose multinational organisations to direct foreign nations’ investments and portfolio investment risks. They reduce the sustainability and attractiveness of a given investment destination. Macro-level political risks also influence policy-making processes in foreign nations or their behaviours towards certain nations.

For instance, the rising of insurgencies within nations, which loot assets and property of multinational organisations, compels foreign nations to curtail certain business operations by their organisations within a specific region or nation.

A study conducted by the Economic Intelligence Unit (2006) found an increasing preference rates for foreign investments in emerging markets.

79-percent of the surveyed people informed that their organisations had increased financial resources that were invested in new markets over a period of three years (Economic Intelligence Unit, 2006, p.3). In the emerging markets, political institutions are weak and subject to control by the unrepresentative elite.

This leads to a subverted process for regulations and laws that make the process together with their applications.

Hence, investors encounter unpredictable and dynamic business environment. Economic Intelligence Unit (2006) reflects the significance of political risk.

96-percent of the respondents maintained that political risks in the emerging markets were incredibly important while making decisions on the location and amount of financial commitment in market investments.

For multinational organisations, political factors are important in the analysis of marketing environments before investing in a new market since they help reveal the degree of political risk in the financial performance.

For instance, the Middle Eastern markets have political volatilities that result from conflicts such as the Israel-Palestine conflict, Syrian conflict, and the instabilities in Iraq and Iran among other regions (Rogman 2004).

It is important to note that different nations play active and passive roles in the resolution of the conflicts.

Where the general public or even a given target market segment opposes the roles played by a given nation in the political conflicts within its nation, probabilities for a negative reception of multinational organisations that are established within negatively-received nations will be higher.

Such challenges may include boycotts for purchasing products and services offered in the market place by international investors.

Political instability, high corruption prevalence, and unstable institutions to control and punish organised crimes such as looting organisational financial resources amplify the risks encountered by multinational organisations.

Although all nations experience incidents of corruption, Economic Intelligence Unit (2006) reveals how corruption is common in the emerging markets.

In fact, it was the second highly important factor that worried many multinational organisations that sought to invest in foreign nations after political stability (Economic Intelligence Unit 2006). Political environments also influence legal and regulatory systems.

Their partiality and inefficiency depend on welded political powers within nations.

Thus, economic instabilities that are brought about by massive corruption and bribery and other challenges such as failing to honour contracts that are entered between the state and a multinational organisation have their roots in political systems and interactions of various key political players.

For multinational organisations that seek to establish international operations in the oil industry, political instability, nationalisation, and expropriation constitute the mega issues to put into consideration in political risks management approaches (Anderson 2009).

Expropriation arises when the host nation seizes the development rights of an organisation and/or its facilities for utilisation by the host nation through national interest guises (Anderson 2009).

Nationalisation takes place whenever a nation takes up development rights and/or facilities that belong to multinational organisations in an attempt to hand them over to a particular host nation’s company.

Even though these two forms of political risks may arise within a short-term, some nations deploy strategies for regulating the operation of foreign corporations through strategies that amount to nationalisation and expropriation in the long-term.

Greco and Meredith (2007, p. 30) support this assertion by asserting, ‘creeping expropriation can come in the form of increased regulations, confiscatory taxes, limits on the repatriation of currency, changes in exchange rates, and forced re-negotiation’.

These strategies also comprise mechanisms through which political risks in the international business arise.

The case of Venezuela perhaps explains well how political risks in international business arise. In 2007, the nation issued a decree (no. 5.200), which demanded all companies, which operate in Orinoco Belt to accept entering new contracts with Venezuela National Company (Anderson 2009).

Failure to comply with the directive amounted to expropriation. Exxon Mobil and Conoco Philips were the immediate victims. In 2006, Ecuador forced multinational oil operators to embrace subcontracting treaties in a bid to ensure cancellation of joint ventures (Zaldumbide 2007).

For this reason together with some other regulations and laws on taxation, Occidental Petroleum Company’s interests were expropriated. Anderson (2009) reveals the possibilities of increasing levies together with various payments made on oil and its related products in Ecuador and Angola among other nations.

Whether an organisation operates in the oil industry in a foreign nation or any other industry, developing strategies for mitigating political risks for international business is one of the most important strategic initiatives.

Many firms are resulting in globalisation as a strategic initiative for gaining competitive advantage. In a bid to mitigate various political risks successfully, both in the short-term and long-term, market entry mode in foreign markets may produce imperative implications on survival in the international markets (Hague & Jackson, 2006).

Therefore, the decisions on survival mechanisms in the foreign nations depend on the prevailing political situations in a host country. They constitute one of the mega decisions a firm has to make before channelling its resources to establish business operations.

Different entry mode options in the international markets are available for multinationals. Typical examples include licensing, joint ventures, exporting, and franchising. Different entry modes possess different merits and demerits.

Hough and Neuland (2000) conducted an analysis of various market entry modes. The authors state that exporting is the easiest mode of selling the firm’s products in foreign markets (Hough & Neuland (2000, p.13).

It permits an organisation to indirectly or directly export. In case of express overseas sales, an appointed partner sells services together with commodities of an international company that is established in a foreign nation.

Direct exporting involves a firm selling its products directly to the importer or a buyer in a foreign market (Hough & Neuland 2000).

Licensing involves entering treaties that involve the substitution of privileges of insubstantial organisational assets for a particular duration that is agreed upon at the time of making the treaties. The proprietor reciprocates the licensor with disbursement benefits.

Franchising involves entering long relationships in comparison with licensing (Ross 2003). In the relationship between the franchisor and franchisee, the franchisor sells critical property, for instance, a trademark to the franchisee (Ilan & McKee 1999).

The franchisor also acquires the franchisee’s contractual responsibility to abide by all rules on its business regulations.

Joint ventures constitute business collaboration between two companies that are based in two or more countries that share ownership of an enterprise that is established jointly for the production and/or distribution of goods and services.

Elements such as opinionated jeopardy, difficulties in successful business operations between nations, and collective threats determine the relativity of the appropriateness of the preferred methods of accessing new markets.

Thus, firms that seek to establish themselves globally need to consider economics and other dynamics of the destination nations (Beamish, Morrison & Rosenzweig 2005). In particular, it is desirable for globalising companies to have plausible information about taxation, labour, and regulation on various royalties that are payable to the government of the host nation.

Hibbert (2005) supports this claim by adding that leaders of firms need to know that the attractiveness of foreign market opportunities is different for different business industries and among individual companies.

Organisations that wish to establish operations in international businesses need to do a number of things.

Hibbert (2005) reveals that these things include the evaluation of international markets business opportunities, conduct analysis of the extent to which a firm may be able to establish potential opportunities for growth in foreign nations, make a decision on the appropriate market strategy, innovate marketing strategies, and then conduct standardisation of various global operations.

While standardising the best mode of operation in a foreign nation, it is plausible for an organisation to reduce the amount of direct investments in assets in nations that have unstable political regimes and/or where trade regulations fail to favour foreign corporations.

Thus, instead of establishing business operations that are under direct management and control of a multinational company, franchising, licensing, and exporting are attractive entry modes in foreign markets that have high political instabilities.

This strategy can perhaps help reduce the risks of nationalisation and expropriation.

Political situations in different market regions foster growth of a specific corporate culture, which may help in building legacy for local or multinational organisations that are established within a given nation or region.

For instance, Rogman (2004) maintains that the lack of significant legacy challenge ensures that local multinational organisations in the Middle East have the advantage of low costs of labour and taxes, few challenges in acquiring favourable transport, and energy for the energy intensive organisations (Rogman 2004).

Therefore, foreign multinational organisations that wish to establish business operations in the region must be prepared to face intense competition from the Middle East multinational corporations such as Qatar Airways and Fly Emirates in the case of the airline industry.

This suggests a possible way of entering these markets without experiencing massive political risks through strategic partnerships with these organisations since they also have legacy advantages compared with foreign multinationals.

The best strategic partnership is the one that does not call for an international organisation to invest in physical assets to minimise losses in the event the business of the organisation comes to a standstill due to political instabilities and expropriation.

Engaging in any international business requires an organisation to invest based on the calculated risks. Multinational businesses that want to exploit new markets should conduct reviews for various ratings of different risk factors (Clark 1997).

More informed investment decisions need support from empirical data (Hamilton & Webster 2012). Hence, multinationals need to collect data, specifically for their own risk assessments.

Just like in the case of Erbil in Iraq, such analysis may reveal that even though operating in high politically unstable environment is inappropriate, such challenges may provide opportunities for success.

The opportunities may also have possibilities of lasting for long while creating the necessity for the adoption of alternative political risk mitigation strategies such as insurance (Hayes & Cummings 2001).

Insurance policies are established depending on the emerging market needs so that organisations can derive well-informed decisions depending on the most probable risks to encounter in foreign market operations.

Private insurers together with governments develop different policies that cover a range of risks including political risks such as nationalisation and expropriation threats (Greco & Meredith 2007).

Examples of organisations that offer these types of insurance coverage include, ‘the US Overseas Private Investment Corporation, the Canadian Export Development Canada, and the UK’s Export Credits Guarantee Department’ (Comeaux & Kinsella 2000, p.214).

Some multilateral organisations also insure companies that engage in international businesses against political risks such as MIGA (Multilateral Investment Guarantee Agency) (Jeffrey 2004). Such organisations operate through World Bank’s sponsorships.

Corporations that wish to mitigate their political risks through MIGA must be considering investing outside their home nations. The guarantees are only available to organisations, which have subscribed to its (MIGA) membership (Comeaux & Kinsella 2000).

MIGA helps in mitigation of risks like confiscation and nationalisation. It is particularly important while developing risks resilience against expropriation. However, Jensen (2005, p. 15) states, ‘In case of creeping expropriation or partial confiscation, coverage may be limited’.

MIGA helps organisations engaging in international business mitigate risks of currency inconvertibility and breaching contracts. Purchasing any political risk insurance is not an outright guarantee for compensation immediately the risk occurs. Some time is required in processing the claims.

This observation suggests that organisations that rely on insurance must also adopt other risk mitigation strategies at least in the short-term for them to continue doing business normally in other areas.

International businesses expose organisations to various risks such as economic, social, cultural, and political risks. Their success in the host nations depends on how they manage different risks. Political risks are somewhat the most dangerous risks that any organisation can encounter.

Wars, expropriation, and nationalisation can lead to total loss of an organisation’s rights and assets. Mitigating these risks can be accomplished in different ways depending on the nature of the risks.

The paper has discussed the development and evaluation of appropriate entry modes for new markets and insurance against political risks such as expropriation and nationalisation as some of the possible ways.

A possible way to avoid risks completely entails making a decision not to establish business operations in foreign nations that have high political risks. However, such markets can be so attractive so that they are worth the risks. In such a situation, the best approach to mitigating political risks is through insurance.

Anderson, S. 2009, Appropriation, Nationalisation and Risks Management , Davis Graham Stubbs, LLP, Dubai.

Beamish, W., Morrison, A. & Rosenzweig, M. 2005, International Management: Text and Cases , Irwin, Chicago.

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Comeaux, P. & Kinsella, N. 2000, ‘Reducing Political Risk in Developing Countries: Bilateral Investment Treaties, Stabilisation Clauses and MIGA and OPIC Investment Insurance’, NYL School Journal, vol.15 no.1, pp. 213-221.

Economic Intelligence Unit 2006, Operating Risks in Emerging Markets . Web.

Greco, S. & Meredith, I. 2007, ‘Getting to Yes Abroad: Arbitration as a Tool in Effective Commercial and Political Risk Management’, Business Law Today , vol. 2 no.1, pp. 23-36.

Hague, P. & Jackson, P. 2006, A guide to planning, methodology and evaluation: Market Research, Kogan Page, London.

Hamilton L. & Webster P. 2012, The International Business Environment , Oxford University Press, Oxford.

Hayes, E. & Cummings, A. 2001, ‘Political Risk and Insurance: Taming the Risks of Project Finance’, International Financial Law Review , vol. 20, no. 3, pp. 17-31.

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Hough, J. & Neuland, W. 2000, Global Business Environments and Strategies: Managing for Global Competitive Advantage , Oxford, Cape Town.

Ilan, A. & McKee, D. 1999, ‘Towards a Macro-environmental Model of International Franchising’, Multinational Business Review , vol. 7 no.1, pp. 76-82.

Ilan, A., Mitchell, M., Gurumoorthy, R. & Steen, T. 2006, ‘Managing Micro-Political Risk: A Cross-Sectional Study’, Thunderbird International Business Review , vol. 48 no. 5, pp. 623-642.

Jeffrey, S. 2004, ‘A Theoretical Perspective on Political Risk’, Journal of International Business Studies , vol. 15 no. 3, pp.123-143.

Jensen, N. 2005, Measuring Risk: Political Risk Insurance Premiums and Domestic Political Institutions , Washington University, Washington, DC.

Rogman, T. 2004, Entry Strategies for Middle Eastern Markets , The World Financial Review . Web.

Ross, B. 2003, ‘Market entry methods for western firms in China, Asia Pacific’, Journal of Marketing and Logistics , vol.15 no. 4, pp. 3-18.

Zaldumbide J., 2007, Nationalisation of the Hydrocarbon Industry in Ecuador, Special Institute: International Mining and Oil & Gas Law, Development, and Investment , Rocky Mineral Law Foundation, Colorado.

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IvyPanda. (2020, May 27). How Political Risks Arise in International Business. https://ivypanda.com/essays/how-political-risks-arise-in-international-business/

"How Political Risks Arise in International Business." IvyPanda , 27 May 2020, ivypanda.com/essays/how-political-risks-arise-in-international-business/.

IvyPanda . (2020) 'How Political Risks Arise in International Business'. 27 May.

IvyPanda . 2020. "How Political Risks Arise in International Business." May 27, 2020. https://ivypanda.com/essays/how-political-risks-arise-in-international-business/.

1. IvyPanda . "How Political Risks Arise in International Business." May 27, 2020. https://ivypanda.com/essays/how-political-risks-arise-in-international-business/.

Bibliography

IvyPanda . "How Political Risks Arise in International Business." May 27, 2020. https://ivypanda.com/essays/how-political-risks-arise-in-international-business/.

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Political Risk Spreads

We introduce a new, market-based and forward looking measure of political risk derived from the yield spread between a country's U.S. dollar debt and an equivalent U.S. Treasury bond. We explain the variation in these sovereign spreads with four factors: global economic conditions, country-specific economic factors, liquidity of the country's bond, and political risk. We then extract the part of the sovereign spread that is due to political risk, making use of political risk ratings. In addition, we provide new evidence that these political risk ratings are predictive, on average, of future risk realizations using data on political risk claims as well as a novel textual-based database of risk realizations. Our political risk spread measure does not make the mistake of double counting systematic risk in the evaluation of international investments as some conventional measures do. Furthermore, we show how to construct political risk spreads for countries that do not have sovereign bond data. Finally, we link our political risk spreads to foreign direct investment. We show that a one percent point reduction in the political risk spread is associated with a 12 percent increase in net-inflows of foreign direct investment.

Siegel acknowledges the financial support from the Global Business Center at the University of Washington. Bekaert acknowledges financial support from Netspar. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

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Multinational enterprises, risk management, and the business and economics of peace

Multinational Business Review

ISSN : 1525-383X

Article publication date: 11 December 2017

The purpose of this paper is to reconceptualize how managers of multinational enterprises (MNEs) manage risk, particularly in fragile and/or conflict-affected areas of operation. The authors suggest that MNEs consider reducing risk at its source rather than trying to avoid or react to risks as they occur. By incorporating peacebuilding strategies, managers may not only reduce investment risk but also contribute to stability and prosperity in the communities where they operate, and gain a competitive advantage in doing so.

Design/methodology/approach

The authors show how firms can take a more holistic approach to working in conflict-affected areas. They do so by overlaying conceptualizations of risk with those of peacebuilding and then use case examples to illustrate how such actions work in practice.

Using a series of examples, the authors find that MNEs that incorporate peacebuilding frameworks in their risk calculations in complex settings tend to have a better understanding of local environments and how they affect firm operations and profitability. These same MNEs may hold a long-term advantage over international competitors that do not share the same understanding.

Originality/value

The authors argue that the study of relationships between international businesses and society in conflict-affected or fragile areas of operation is under-developed and tends to focus on negative (risk-aversion) aspects as opposed to positive (value-added) opportunities. This paper offers new ways in which these relationships can be reconceptualized. The authors’ main takeaway is that a peacebuilding approach does not require corporations to be arbitrators of peace at the expense of profit. Rather, it is instead a broader way to conceptualize and weigh risk when working in the world’s most challenging regions. This approach is more likely to be in the long-term interest of both the firm and the local society where the firm operates.

• Risk mitigation
• Corporate sustainability
• Peacebuilding
• Business for peace

Oetzel, J. and Miklian, J. (2017), "Multinational enterprises, risk management, and the business and economics of peace", Multinational Business Review , Vol. 25 No. 4, pp. 270-286. https://doi.org/10.1108/MBR-09-2017-0064

Emerald Publishing Limited

Copyright © 2017, Jennifer Oetzel and Jason Miklian.

Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial & non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode

Introduction

Understanding the environments in which multinational enterprises (MNEs) operate is a major topic of interest in international business. The institutional, cultural, political and economic characteristics of different countries and their impact on business activity have received substantial attention in the research ( Brouthers, 2013 ; Cantwell et al. , 2010 ; Luo, 2006 ). Related research has also focused a great deal on the risks that businesses face including institutional failures, crime, political instability and violence ( Asongu and Nwachukwu, 2017 ; Dai et al. , 2016 ; Darendeli and Hill, 2016 ; Fatallah, 2017 ; Henisz et al. , 2014 ; Katsos and Alkafaji, 2017 ; Oetzel and Getz, 2012 ; Oh and Oetzel, 2017 ; Ramos and Ashby, 2017 ). As international business scholars, we spend a great deal of time focusing on how to protect MNEs from risks, but seldom do we focus on how managers of MNEs might reduce risk at its source and promote peace and stability in countries facing complex challenges. Our goal in this article is to suggest that business can, in fact, contribute toward peacebuilding and that there are numerous self-interested reasons that managers may choose to do so.

To some, peacebuilding[ 1 ] may seem like an unlikely topic for the business literature. If polled, it is likely that a significant number of managers of MNEs would not consider peacebuilding as the “business of business”. For many academics and practitioners in conflict-prone regions of the world, however, it goes without saying that managers must understand how to address violence and political risk and work to strengthen institutions, promote the rule of law and support social justice.

For example, while every age has it grand challenges, today, businesses and societies are concerned with ongoing terrorist threats, political conflict, the rise of populism in many parts of world, including the USA, Britain and the Philippines, and strong anti-globalization sentiments. There is also a sense that global business and trade are leaving some portions of society behind. Given the central role that MNEs play in many of these debates, managers may need to consider how to effectively approach these types of problems.

One of the challenges in starting to think about the role of business in promoting peace is that peace, as a goal, is hard to define and difficult to measure. If a country is experiencing conflict and political violence, however, the risk and its impact on business and FDI can be immediate and obvious to managers ( Seno-Alday, 2015 ; Suder and Czinkota, 2005 ; Vijayakumar et al. , 2009 ). The result is that social scientists have generally focused more research on violence, conflict and political risk than on how to promote peace and stability. Contributing to the imbalance in research is the fact that, at least in the USA, research on conflict generates significantly more grant money than peace-oriented studies.

Another challenge is how to determine the factors that lead to a more peaceful society. In much of the contemporary literature, peace is defined as the absence of violence or negative peace. As peace is more than the absence of violence, this definition is incomplete. Positive peace suggests that at a minimum, there is a fundamental sense of justice and fairness, widespread economic opportunity, a legal system that functions freely and fairly and that the factors that caused conflict in the first place are not just suppressed but eliminated ( Galtung, 1969 ; Oetzel et al. , 2010 ). While there are certainly many other factors that are relevant to peace, businesses, especially MNEs, are unlikely to address all of them, and business cannot be expected to eliminate conflict on its own.

Before we discuss in greater detail how and why peacebuilding is relevant for international business, it is important to recognize that business is just one of a larger set of actors working to reduce conflict and increase peace. We also are not suggesting that businesses should be responsible for fixing all the problems in a country. In fact, historical evidence suggests that when business actually supplants the role of government and civil society, the outcomes can be grim ( Reiff, 2000 ). Instead, our goals are to discuss how businesses might engage in peacebuilding, review what the benefits are to business of working toward positive peace and suggest how MNEs can avoid unintentionally contributing to conflict.

Business and peacebuilding

Why would multinational enterprises adopt peacebuilding strategies.

If managers could actually reduce risk at its source, and possibly gain a competitive advantage by doing so, that would be a powerful motivation for peacebuilding as a means of risk mitigation. Doing so requires new ways of conceptualizing the problem and a willingness to redefine what we mean by risk management ( Bansal et al. , 2017 ). Several reasons that this process has begun to happen over the past two decades is because of the limitations and failures of current approaches, the changing expectations of stakeholders and the need for managers of MNEs to recognize and to address the complex risks facing business and society. Here we discuss each of the reasons in turn.

Limitations and failures of current approaches.

The natural desire to avoid risk or to rely on governments to manage it is understandable. The problem with this approach is that avoidance is not realistic in the complex and dynamic business environment that many MNEs are facing today. In addition, many governments today lack the resources, capabilities or the will to contain problems within their borders. This puts the onus on managers to address problems that are traditionally the responsibility of the public sector.

Changing expectations.

There are many reasons why MNEs may engage in peacebuilding efforts. One recent example is the case of Apple, Intel, Tiffany & Co., among others, and the 2010 USA Conflict Minerals Law overseen by the Security and Exchange Commission. The law requires US companies to avoid using minerals that fund conflicts and lead to human rights abuses in the Congo region. Contrary to many news reports indicating that business was staunchly against the law, once politicians suggested that they intended to eliminate it or water it down, businesses like Apple, Intel and Tiffany & Co. publicly announced their vocal support of the provision. According to the companies involved, the law has “created an expectation both inside their company headquarters and among consumers that their products will be ‘conflict free’” ( Frankel, 2017 ). Eliminating the law, many groups argue, (e.g. the International Conference on the Great Lakes Region, 41 Congolese civil society organizations, Pact, etc.) would lead to a significant increase in violent conflicts in Congo. In this case, even though peacebuilding may not be the primary reason that the companies involved are supporting the Conflict Minerals Law, the fact is that their actions do make a positive difference for those living in conflict-affected countries. Moreover, widespread industry support for the law increases the power of the legislation.

Need for multinational enterprises to address complex risks that affect business and society.

Even when businesses do not actively seek to promote instability, they may find that their day-to-day operations are unintentionally contributing to violence and conflict. The creation of the Global Internet Forum to Counter Terrorism is an example of one such effort to address this type of problem. Facebook, Microsoft, Twitter and Google (YouTube) have joined together to make it harder for extremist groups to use their hosted consumer services to promote terror and violence ( Burgess, 2017 ). The group’s aim is to formalize and structure existing and future areas of collaboration between member companies and foster cooperation with smaller tech companies, civil society groups, academics, governments and supra-national bodies such as the European Union (EU) and the United Nations (UN). A similar group exists in the, the EU internet forum.

Gain a competitive advantage.

MNEs that understand how to directly or indirectly reduce risk may find that they are well positioned to take advantage of business opportunities that other firms avoid. One example is the case of Four Seasons Hotels. Unlike many of its competitors, the Four Seasons has been able to open new hotels in countries facing violent conflict ( Conlin, 2006 ; Oh and Oetzel, 2017 ). For example, despite the fact that Lebanon was in the midst of war in 2006 after the assignation of Rafic Hariri (the former Prime Minister of Lebanon) in 2005, the Four Seasons continued its plan to establish a new hotel in Beirut. After a planning period, the new hotel opened for business in 2010. The company prides itself on the fact that, “After 9/11, we were one of the few hotel companies that did not stop any of our projects” ( Conlin, 2006 ). These reports suggest that the Four Seasons has developed internal capabilities around risk management that enable it to operate in politically risky environments. Given their track record post-9/11, it appears that they may have an advantage over their competitors.

Building on the previous example, academic studies have shown that context-specific knowledge or local ties may lead to an advantage when managing complex risks. In one study of 379 MNEs and their subsidiaries operating across 117 countries, researchers found that firms with a deeper knowledge of the country-context are less likely to decrease their investments in conflict affected locations, even as the conflict intensifies ( Oh and Oetzel, 2017 , p. 714). In another study, researchers found that MNEs facing severe political risk can increase their chances of survival by strengthening their social ties and, “by offering goods or services that are perceived as socially valuable” ( Darendeli and Hill, 2016 , p. 68).

While these examples are not explicitly about peacebuilding efforts, other researchers have demonstrated that firm expertise in cross-sector collaborations or “partnerships for peace” aimed at reducing risk and promoting peace do have the potential to confer competitive advantage to firms operating in conflict zones ( Kolk and Lenfant , 2015a, 2015b ). In fact, there is evidence that knowledge of conflict-affected environments may spur innovation, particularly around MNE response to risk ( Jamali and Mirshak, 2010 ; Kolk and Lenfant , 2010, 2016 ).

Is peacebuilding by business actually happening in practice?

To some extent, academia is behind business practice in terms of recognizing the limits of existing business tools to address complex challenges in international business and acknowledging that MNEs have a role to play in contributing toward more peaceful and secure societies. The International Council of Swedish Industry (NIR) is arguably the leading business association in Sweden. The aim of NIR is to “support and broaden the scope of operations of Swedish business in markets which are politically, economically or socially complex” ( NIR, 2017a ). The organization specifically lists “Business and Peace” as one of its areas of expertise. The challenge with accessing many of the world’s fastest growing markets, suggests NIR, is that:

[…] with many of the world’s fastest-growing markets experiencing violent conflict or undergoing post-conflict processes, business increasingly faces concerns about how their activities may aggravate or alleviate the effects of violent conflict. Legitimate private sector actors have an interest in peace and political stability. Threats of open violence, lack of stable political institutions and unpredictable economic frameworks hinder or even prevent private sector activities from taking place by increasing operating costs and disrupting lines of supply. While the primary responsibility for peace, security and development must rest with governments, private sector actors can make an important contribution to stability and security in conflict-affected and post-conflict areas ( NIR, 2017b ).

Encouraged by many of the largest MNEs in Sweden to provide guidance on these issues, NIR has produced several publications including Managing in Complex Environments: Questions for Leaders and Private Sector Actors and Peacebuilding .

Another organization that promotes peacebuilding by managers is the “Business for Peace Foundation”, also in Oslo. Since 2009, this organization has recognized well over 40 business leaders from around the world, including Richard Branson, Paul Polman and Elon Musk, for their contributions to peacebuilding at the annual “Oslo Business for Peace Summit”.

As suggested earlier, an especially challenging aspect to many of these issues is that the solutions to conflict reduction and peacebuilding are generally context-specific ( Oh and Oetzel, 2017 ). Further, conflict dynamics rarely fit into neat categories like “post-conflict” or “formal peace” in practice, making it hard for even peace practitioners to be able to accurately survey conflict landscapes for risks and opportunities. Academics and practitioners in international business, however, should be well positioned in this respect. By definition, international business requires an understanding of the institutional, cultural, political and economic context in which business takes place ( Suder and Czinkota, 2005 ). Next, we discuss specific strategies and tactics that firms can adopt to promote peacebuilding.

What can businesses do?

There are a variety of strategies and tactics that managers can use to reduce conflict and promote peacebuilding. In deciding what approach to take, managers must consider whether they want to act alone or in collaboration with other firms or organizations. Depending upon the particular challenges at hand and the resources and capabilities of the firm, managers may choose to directly or indirectly reduce risk at its source by mitigating the factors that undermine peace ( Oetzel et al. , 2007 ).

For many reasons, we expect that most firms will choose to work with other organizations, either formally or informally. The benefits of doing so are numerous. First, this approach enables firms to share any costs associated with their efforts. Second, to address complex challenges, different perspectives are often quite valuable. Organizations working together from different sectors may also develop more creative solutions. Third, as managers are not trained to think about reducing risk at its source or to engage in peacebuilding, the necessary expertise is often outside the firm.

Most firms will probably not work alone to directly reduce risk at its source, but those that do will tend to be large MNEs with substantial resources. Anglo–American Mining Company is one such company that has been credited with directly promoting peace. Concerned about its ability to raise capital and its overall profitability and survival during the Apartheid era in South Africa, Anglo–American reportedly facilitated negotiations between the African National Congress (ANC) and the South African government between 1984 and 1990 in an effort to promote peace in the country ( Lieberfeld, 2002 ; Oetzel and Getz, 2012 ). While only a firm with the size and influence of Anglo–American mining is likely to have the power to bring two groups like the ANC and Apartheid government in South Africa to the table for meaningful peace negotiations, firms of all sizes can play a positive role in mitigating violence and promoting peace.

Any organization can work to indirectly affect the factors that undermine peace in a country. For example, firms can act alone to address ethnic conflict or racial tensions in the work place. Doing so may not only improve organizational culture and productivity but also can have positive spillover benefits to the wider society (Benjamin et al. , 2015; Bader and Schuster, 2015 ; Lee and Reade, 2015 ; Reade and Lee, 2012 ).

Managers can also audit their supply chains to make sure they are not directly or indirectly fueling conflict. Mo Ibrahim, founder of African mobile phone giant Celtel, has demonstrated that it is possible to operate in highly challenging environments without contributing to conflict or engaging in corruption. In the early days of Celtel in Africa (late 1990s), the company entered several countries embroiled in civil wars. One such country was Congo, specifically Brazzaville, the capital. At the time Celtel entered:

[…] the city of Brazzaville was filled with checkpoints staffed by armed combatants, including child soldiers. Buildings had been looted, their windows blown out, and there was no functioning road between Brazzaville and the second-largest city, Pointe Noire. The instability of the area kept the UN from sending its personnel to the country. ( Jones and Campbell, 2014 , p. 11).

Despite the challenging country conditions in Congo, Celtel realized that there were no other cellular services to speak of and phones were in high demand. Thus, because of the ongoing conflict, there was virtually no competition.

Celtel did not let the environments where they operated affect their approach to business. In a number of conflict-affected and corrupt countries they entered, the company never “adapted” to the environment by paying bribes to purchase telecommunications licenses or to set up their cellular towers. Instead, they made their no bribes policy clear up front. In one country, Celtel found that there was no way to avoid paying a bribe if they wanted to operate there. Rather than do so, Celtel withdrew from the country and forfeited a sizeable initial investment in infrastructure ( Jones and Campbell, 2014 ).

Mo Ibrahim’s successful approach to doing business in Congo and other conflict-affected countries in Africa demonstrates that there are alternatives to “business as usual”. His actions have inspired other managers and their firms to follow in his footsteps, and he is now a highly influential thought leader on corporate governance in Africa.

Discussion and examples of multinational enterprises practices around peacebuilding

On the basis of our review of the literature and first-hand case studies and interviews, we propose that MNE practices around managing complex challenges follow something of a normal distribution. On one end of the distribution, there are firms engaged in war profiteering or are operating in such a way that managers knowingly benefit from and contribute to an increase in violence and conflict. For most firms in the distribution, however, we expect that they are neither consciously working toward peace nor intending to foster instability or conflict. In some cases, business as usual can actually have a large positive impact on a country simply by providing jobs and promoting economic growth ( Fort, 2007 ). To the extent that businesses generate employment, offer a fair wage, good working conditions, etc., they can positively contribute to people’s lives, decrease unrest and, in some cases, reduce risk at its source. Unfortunately, it is not hyperbole to say that “getting ahead based on your merits” and having safe working conditions and fair compensation are still only aspirational in many parts of the world. If all businesses met these most basic of standards, the economic life of millions of people could be transformed.

At the far end of the distribution, there are firms that are actively formulating strategies and business practices aimed at minimizing risk at is source and promoting peacebuilding. An important point, however, is that firms rarely define a strategy as a “strategy to promote peace”. Rather, managers may define a firm’s actions by the issue it addresses or the long-term economic and social effects it has on society. For example, Paul Polman, the CEO of Unilever, received the Business for Peace Award in Oslo, Norway, for his efforts to reduce Unilever’s environmental footprint and increase its positive social impact while simultaneously doubling the size of the corporation. While the Anglo–American example in South Africa is clearly and directly aimed at peacebuilding, Unilever’s approach is not explicitly about peace. Nevertheless, by taking into account the environmental and social impacts of its business, the company has increased the economic, social and health-related well-being of those in its supply chain. In turn, these actions may reduce the likelihood of conflict in the areas where Unilever operates and enhances the prospect for long-term stability and peace.

Another example is the case of Starbucks. In response to the international refugee crisis, Starbucks announced a pledge (in January of 2017) to hire 10,000 refugees worldwide over the next five years ( Spary, 2017 ). Doing so is expected to reduce the rate of social unrest, help refugees to better integrate into their new home country and reduce the need for government assistance – outcomes that enhance stability and promote peaceful societies. Interestingly enough, a non-profit organization called Duo for a Job in Belgium has received international attention doing similar work. Unlike Starbucks, the organization does not directly employee program participants. Although the non-profit organization’s work is considered highly impactful, because of its non-profit status, Duo for a Job is only able to reach a small portion of the people that Starbucks will in the course of its program.

Starbuck’s effort is not exclusively altruistic. According to a consumer research firm in the UK, the British exit from the European Union (i.e. Brexit) will lead to a shortage of 40,000 baristas by 2025. By hiring refugees, at least in the UK, Starbucks not only helps refugees in need of employment but also benefits the company’s bottom line. Starbucks’ policy is not without its critics. Some consumers in the USA have advocated a boycott of the company suggesting that Starbucks put “America First” ( Spary, 2017 ). Starbucks seems to be willing to take the heat, however, possibly emboldened by outgoing CEO Howard Shultz’s dedication to the issue. It appears that the long-term financial, reputational and humanitarian benefits of the policy are significantly greater than short-term threats to the business.

When “business as usual” unintentionally fuels conflict

While MNE behavior within and across countries is likely to vary substantially, in general, given the population of firms we discussed earlier, a large number of MNEs are going about “business as usual” and neither consciously working toward peace nor intending to foster instability or conflict. Doing business as usual, however, can unintentionally worsen peace dynamics in fragile places. While firms can help to grow markets and thus contribute to improved conditions for peace, they can also exacerbate underlying conflict dynamics when they do not understand the context in which they do business and the impact of their operations. Businesses may also be ignorant of, turning a blind eye to or considering themselves not responsible for, the actions of their local partners. At times, local partners may engage in activities that contribute toward conflict and may violate national and international laws.

In this section, we briefly explore a few cases where MNEs, doing business as usual, have threatened peace and stability in the countries where they operate. These cases illustrate how the seemingly benign practices of partnering with local firms and outsourcing certain business activities to local providers can have serious consequences. These consequences for the MNEs may include legal liability, increased operational risk and damage to firms’ reputations in the home and host markets. Following the case examples, we discuss alternative strategies for dealing with the complex problems raised in these cases. The first examples focus on Microsoft and Coca-Cola in Myanmar.

Microsoft and Coca-Cola in Myanmar.

Microsoft and Coca-Cola were two of over 200 Western MNEs to enter Myanmar, or significantly expand operations there, when Myanmar’s military junta announced plans in 2011 to liberalize. Ranking 170 of 190 countries surveyed by the World Bank in ease of doing business ( World Bank, 2016 ), most sectors of Myanmar’s economy have seen a dramatic expansion in investment, supported by international aid and development agencies under claims that foreign firms are solidifying a fragile peace through rapid socioeconomic development. While businesses are generating economic growth in the country, the unevenness of the distribution of wealth and opportunity has worsened societal cleavages. This is a serious concern as Myanmar still has 18 ongoing conflicts with most rooted in the uneven division of economic opportunities and civil rights, along with the heavy-handed rule used to maintain stability. There is little indication that economic inequality in the country will improve in the near-term. For one reason, Myanmar’s new wealth has largely been captured by elites who expropriated valuable assets when the country liberalized its markets. Also, because of a government policy requiring MNEs to form joint ventures with local partners, these same elites (who are highly politically connected) have become the natural local partners for foreign firms entering Myanmar.

For Microsoft, the policy that required MNEs to form joint ventures with local firms has meant launching a multimillion dollar joint venture in 2013 with the Shwe Taung Group, led by Aik Htun. Htun has been flagged by the USA Treasury as being a major drug trafficker and money launderer ( Peel, 2015a ), and he and his family are also subject to EU sanctions for corruption and money laundering in his former role as owner of Myanmar’s largest bank. Shwe Taung Group is the sole licenser for Microsoft products in Myanmar. In response to the allegations, Microsoft claimed a “formal process of due diligence that includes verifying our (subcontractors) against the relevant local as well as US laws and regulations” ( Peel, 2015a ), and as of July 2017 continues to partner with Htun.

For Coca-Cola, this meant launching a partnership in 2012 with Daw Shwe Cynn, a jade kingpin under sanctions and barred from selling in the USA and other countries ( Peel, 2015b ). Cynn’s firm has also been accused of human rights violations, corruption, land-grabbing and extensive environmental pollution in his jade empire ( Global Witness, 2015 ). Located in Kachin, it is also the site of an ongoing civil war between the government and Kachin Independent Army. In response to the allegations, Coca-Cola conducted:

[…] additional due diligence after engagement with the NGO Global Witness. While our original assessment was based on the best information at the time, (new) findings were consistent with our original due diligence [ (The) Coca-Cola Company, 2014 ].

As of July 2017, Coca-Cola continues to partner with Cyun.

While both firms (and many others in similar situations in the country) argue that they have followed proper due diligence procedures and are thus not legally liable for the actions of their partners, the fact remains that both firms continue to partner with conflict-inducing actors. These partnerships only legitimate and empower such actors. Thus, standard benchmarks for due diligence when selecting local partners in conflict settings have failed to consider such actors as sufficiently risky and left the companies exposed to major reputational and operational risk.

Why do these situations occur? During the process of selecting a local partner, Coke and Microsoft may have felt that they could only choose between potential partners who had ties to government and private sector elites. It is also possible that partnering with these firms may have paved the way for foreign firms to gain a quick foothold in Myanmar. Unfortunately, legitimizing and empowering questionable local partners contributes toward damaging Myanmar’s broader business ecosystem at a time when professional skills are needed. For example, elites in Myanmar have not only consolidated their control of revenue and trade streams but also garnered increasing support for the expansion of ethnic cleansing campaigns. By engaging in such campaigns, elites are better positioned to secure new operational monopolies ( Miklian, 2017a ). Thus, while no single MNE is definitively “causing conflict” through its partnerships, the collective effect of hundreds of such relationships has facilitated an environment where suppression, ethnic cleansing and conflict are growing even as Myanmar’s GDP spirals upward. The next two cases show how subcontracting, even though it is “business as usual”, can increase violence and undermine peace and stability.

Beer in the Congo and Colombia[ 2 ].

The global beer trade has undergone a decade of rapid expansion and consolidation and carries a global product reach that is nearly unprecedented; or as Heineken put it in a recent ad campaign, “In 172 Countries and Still Thirsty”. However, getting the beer from the production plant to the farthest reaches of the country can be a challenge, especially so in conflict regions with poor infrastructure and battles over transport lines between conflict actors. The cases of Heineken in the Democratic Republic of Congo and AB InBev in Colombia show how firms outsource risk by outsourcing business activities to conflict actors (knowingly or unknowingly) to gain and maintain access to markets.

Delivered under the Bralima brand in the DRC, Heineken controls around 70 per cent of the country’s market share and contributes a staggering 35 per cent of the state’s revenue ( Miklian and Schouten, 2014 ). Heineken operates like most DRC MNEs. To minimize risk and maximize profits, managers will, at times, use subcontractors for the most difficult or sensitive tasks ( Miklian and Schouten, 2014 ; Miklian, 2017c ).

In continuous operation since 1923 and bought by Heineken in 1960, Bralima has successfully negotiated their way through dozens of DRC conflicts. Since 1996 alone, 10 per cent of the country’s 77 million people have been killed and new conflicts erupt almost annually, including most recently in Central Congo’s Kasai region. The primary sources of revenue for rebels are the ubiquitous checkpoints placed on nearly all rural roads throughout the country. The checkpoints themselves are often little more than a wooden log or rope thrown across a muddy trail, perhaps with a shack nearby sheltering armed rebels ( Miklian and Schouten, 2013 ). Still, even a single checkpoint can bring in over $1m per year ( UNGOE, 2008 ). This business model supplies enough money to fund a conflict in a country where the average wage is a dollar a day and AK-47s cost about $50 ( Miklian and Schouten, 2013 ).

Bralima is not exempt from extortionary “taxation”. The company pays over $1m per year to such groups ( Miklian and Schouten, 2013 ). For example, Mr. Damien, “tax collector” for the Congo rebel group M23, explained in 2013 that he charges a van about $38 to pass, $300 for a goods truck, and $700 for a fuel tanker, and hands out official-looking receipts upon payment ( Miklian and Schouten, 2013 ). These checkpoints served as a significant source of funding for M23, which was in turn used to purchase weapons, pay insurgent salaries and even deliver social aid to eastern Congo’s poor in exchange for allegiance. Damien said that M23 takes $500 from the trucks hauling crates of Primus into rebel-controlled areas: “NGOs pay, people carrying charcoal pay, women going to the market pay – everyone pays! We don’t do preferential treatment. So, of course, those who transport beer also pay” ( Miklian and Schouten, 2013 ).

If such payments were directly made by Heineken, they could be considered a violation of several laws in Holland, the USA and UN-supported sanctions. Thus, the firm uses a subcontractor model whereby independent truck drivers pick up the beer and are responsible for delivering it across the country. Any expenses, damages or conflict along the way is considered the sole responsibility of the drivers. The local Bralima headquarters in DRC’s capital Kinshasa also considers this issue outside their jurisdiction.

These dynamics are echoed in Colombia where SABMiller–AB InBev controls over 90 per cent of Colombia’s beer market and generates nearly 80 per cent of Colombia’s consumer tax revenue on sales of US$10bn/year ( Arbeláez and Sandoval, 2006 ; Dinero, 2016). Delivered under the Bavaria banner, SABMiller–AB InBev has used a subcontractor model similar to Heineken. For decades SABMiller–AB InBev has used subcontractors to deliver beer to areas controlled by rebel groups in the country, most notably the Revolutionary Armed Forces of Colombia (FARC) and National Liberation Army (ELN) but also including paramilitaries, drug traffickers and other conflict actors. These checkpoint revenues generate a substantial revenue stream that is used to fund insurgent activities.

Like most firms tasked with distribution in Colombia, Bavaria chose to pay both rebel and paramilitary groups in rural areas to continue operations throughout the 1990s and 2000s. From 1991 to 1998, it is estimated that Bavaria faced looting and extortion by guerrillas amounting to an illegal levy of approximately US$1.8m ( Morales et al. , 2012 ). Initially, Bavaria refused to pay the levy and faced retaliation from FARC ( Pax-Christi, 2002 ). Seven Bavaria factories were shut down and FARC imposed a beer ban across its area of control for several months ( El Tiempo, 2001 ). Eventually, Bavaria settled on a solution. In conflict regions, it would continue to produce beer but turn over sole responsibility for distribution to subcontractors. Bavaria’s contractors are thus SABMiller–AB InBev’s sub-sub-contractors. As one Bavaria senior distribution executive working in the conflict zone explained ( Bull and Miklian, 2018 ):

There were times when (distributor) trucks were incinerated. Let me be clear – Bavaria was never going to let themselves be formally tied to anything illegal. Often, the (Bavaria) distributor had to pay extortions and (the rebels) made a lot of money, becoming very important regional players. (Still,) the company sees itself as unrelated to the conflict.

Delivery drivers subcontracted by Bavaria support this assessment. They say that guidance from the firm is limited to unrealistic claims to simply, “not go into the bad areas” (but meet your sales goals), reimbursing drivers for extortionist payments in exchange for receipts and using the firm’s lawyers to negotiate driver releases when they are kidnapped. One driver put it succinctly: “We are on our own the moment we drive out of the distribution center” ( Bull and Miklian, 2018 ).

Considering peace-sensitive business practice

So, how might a conflict-sensitive approach improve the above cases? We recognize that leaving a market entirely is not always feasible or realistic. In addition, managers may focus more on the opportunity cost of leaving a potentially lucrative region rather than on the risk of staying. In addition, doing so may actually be counterproductive to business interests and even to peacebuilding if firms with less interest in conflict sensitivity and human rights take the place of those that leave. However, firms hold a significant amount of untapped political and social capital that can be unlocked through incorporating peacebuilding into risk frameworks. For example, nearly all firms entering Myanmar have stated their support of international human rights aims and established corporate social responsibility norms for operating in the country. The joint venture partners of these MNEs, however, may not share the same concerns.

Alternatively, managers can step back and leverage the substantial economic and reputational power of their MNEs. For example, both Coke and Microsoft could demand to choose a local partner whose practices are consistent with its stated values and whose actions do not violate international or MNE home country laws. In fact, they may have more leverage now than when first entering Myanmar given the global power of their brands and lack of precise substitutes. Also, if an MNE’s actions (i.e. partnering with local firms that violate human rights and engage in widespread corruption) are inconsistent with its stated values and legal obligations, NGOs are increasingly willing to raise the alarm on such perceived corporate hypocrisy. Rather than decreasing its political risk by partnering with unsavory local partners, MNEs will actually increase their risk exposure. The resulting damage to the global brand may not only hurt the MNE internationally but also undermine its reputation and threaten its long-term social and legal licenses to operate in the host country.

This outcome is not hypothetical. After the fall of Suharto in Indonesia in 1998, and the overthrow of Mubarak in Egypt in 2011, it became clear that many MNEs were complicit in the widespread corruption in both countries and turned a blind eye to the behavior of their local partners. Although these MNEs benefitted from the favors of these regimes while they lasted, the ultimate outcome was devastating in many cases. MNEs lost millions of dollars in investments in some cases and the countries as a whole suffered from substantial divestment by foreign firms ( UNCTAD, 1999 ).

For Heineken and SABMiller–AB InBev, the reliance on subcontractors to use a “see no evil, hear no evil” hands-off approach regarding how their operations fund conflict is more problematic. These firms are paying rebel groups and paramilitaries millions of dollars with full knowledge at the national, regional and often global executive levels, that this money funds wars and terrorizes citizens. However, if they stopped working in such areas, these same rebels might simply import the products on the black market themselves and create a new lucrative revenue stream.

While there is no easy solution to this problem, one approach is to leverage the company’s “supplier” power. The beer companies could leverage the strong demand for their product to propose the terms of trade. While less likely, it may also be possible for the beer companies to refuse to pay the “tax” and negotiate an alternative arrangement. This option was reportedly used by at least one oil company during the civil war in Angola during the 1970s. Rather than pay bribes for a license to operate (money the company knew would be used to buy arms), the company negotiated a deal to build schools and provide social services[ 3 ]. Although the beer distributors may not have the political and economic leverage of a multinational oil company, they often have repeated dealings with the same group of combatants. As such, it may be possible to find an alternative agreement so that the company can provide schools or other social benefits but avoid making payments that will be used to fund conflicts. Finally, the guerrillas may also be aware that if these beer companies leave because of the difficult conditions they face, other companies may not fill the void.

Like the beer companies, Indupalma, a Colombian palm oil company, also faced violence and extortion by guerrilla groups. The ongoing threat to Indupalma’s employees, products and operations required the company to make substantial investments in security. As the costs associated with conflict increased, the company began to consider bankruptcy. Rather than close down or pay a security “tax”, the company completely changed is organizational structure (Rettberg, 2004). Indupalma outsourced production to some of its former employees who had formed cooperatives. Indupalma then specialized in financing production, selling equipment and seeds to the cooperatives and then buying their output and selling it in global markets. The guerrillas were much less likely to target small farmers for extortion and the decentralized structure made the central office less of a target. All in all, Indupalma’s strategy was reportedly quite effective ( Rettberg, 2004 ).

At times, managers may not be able to find an alternative to paying the guerrillas’ “tax”. In that case, the company should think seriously about whether to continue to operate in such locations. In the case of Colombia, US companies that paid “taxes” to guerrilla groups have faced heavy fines and sanctions by the Justice Department; some of these include the Drummond Coal Company and Chiquita Brand International. Chiquita was found guilty of paying bribes to terrorist organizations that killed thousands of people in Colombia; the same type of bribes demanded of (and paid by) the beer companies. As a result of its actions in Colombia, the US Justice Department imposed a $25m fine on Chiquita ( CBS News, 2011 ).

We recognize that these cases are far more complex than presented here. A more in-depth discussion of these and other business-conflict interactions can be found elsewhere ( Miklian , 2017a, 2017b ; Miklian and Schouten, 2014 ; Miklian and Hoelscher, 2017 ; Miklian and Medina-Bickel, 2017 ). Our main takeaway, however, is that a peacebuilding approach is not one that requires corporations to be arbitrators of peace at the expense of profit. Rather, it is instead a “thicker” way to conceptualize and weigh risk when working in the most challenging business regions of the world ( Miklian et al. , 2016 ). We feel that such an approach is both more likely to be in the long-term interest of the firm and the local society where the firm operates.

Conclusion and future directions

Rethinking how businesses respond to complex global challenges requires a change in mindset. It is not surprising that to some, peacebuilding sounds like a radical approach to business. After all, the field of business strategy was heavily influenced by military strategy. The writings of Sun Tzu, a famous Chinese military strategist in the sixth century B.C., and Carl von Clausewitz, a Prussian general and military theorist, have heavily influenced how managers approach business decisions and formulate strategy ( Holmes, 2010 ; McNeilly, 2011 ).

For those who live in challenging environments, particularly those in countries with the greatest external risks, the notion of peacebuilding is not at all surprising or radical. The only way to reduce violent conflict risk and address complex challenges around the world is to mitigate risk at is source. Large portions of society have a self-interest in addressing these threats, even if the actual violence is somewhat distant. As an article in this issue demonstrates, while the direct effect of violence, unrest and crime may be localized, the negative effects often extend well beyond the affected area. These threats can create a negative halo effect that deters foreign direct investments (FDI) across large portions of a country ( Ramos and Ashby, 2017 ). This only increases the value of peace for everyone in a violence stricken region of the world.

We see two important avenues for future research in particular. First, as our understanding of how business and society interact in conflict-affected or fragile areas of operation is relatively under-developed, managers must be willing to change their mindset on how to approach risk. Rather than adopting an exclusive focus on mitigating threats (risk aversion), we suggest that managers consider the positive (value-added) approaches that might simultaneously reduce risk and improve the overall conditions for business. Second, while researchers have identified strategies for promoting peace and stability ( Oetzel and Getz, 2012 ; Miklian, 2017c ), there is still a great deal to learn about which strategies are the most effective.

Second, private sector engagement in support of the UN’s sustainable development goals (SDGs) provides a natural but heretofore under-studied way to examine business actions for peace. Goal #16 (peace, justice and strong institutions) is of particular interest, as it directly encourages deeper involvement by businesses in conflict-affected states to help deliver a peace dividend, and the UN considers the private sector to be an essential partner in this agenda. This agenda is also a major shareholder concern as over US$2tn in investments is already benchmarked to sustainable social investment, and another US$20tn is directed to do the same by large pension funds. These figures are growing rapidly, driven by a new generation of investors that demand more socially responsible companies to invest in, incorporating around 20,000 companies that are formal signatories to peace and sustainable development initiatives around the world. Corporate engagement in the SDGs constitutes a mind-bogglingly large undertaking, but we still know little about what actually works (or even what is actually happening) as the private sector increasingly works to build peace through sustainable development in fragile and conflict contexts.

It is important to note that managers do not need to be experts in peacebuilding to adopt the strategies and tactics we have discussed here. For those companies who are open to trying alternative approaches to risk management, there are many external organizations like NGOs that can serve as valuable partners and/or resources. These organizations often have unique skillsets and knowledge of local peace and conflict dynamics that can be invaluable for the business community. NGOs often have experience mitigating conflict and can provide the skills and capabilities needed by MNEs to reduce risk. In turn, MNEs can offer guidance to NGOs on political risk, corruption and other elements of “doing business” that can help NGOs navigate private sector environments where they may be seen as the enemy. The critical point is that peacebuilding is actionable. Moreover, there are numerous self-interested reasons that managers may choose to do so.

Many of the challenges in the world today cannot be addressed by one segment of society. The public sector is stretched thin, is increasingly decentralized and, in many countries, lacks the resources and capabilities to solve problems within a country. As stable, peaceful societies are highly desirable for business (e.g. businesses pay a premium to locate in countries like Singapore where the rule of law is strong and the necessary conditions for peace are present), managers have an interest in peacebuilding and, in many cases, the power to do it.

In a post-conflict context, peacebuilding has been defined as identifying and supporting structures which will tend to strengthen and solidify a more peaceful society to avoid a relapse into conflict (as defined in Barnett et al ., 2007 ).

The authors thank Juan Pablo Medina-Bickel for his research assistance in this section.

In an off-the-record meeting, a former top executive of a major oil company related this arrangement that he brokered in Angola (2007).

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Further reading

Bader , B. , Berg , N. and Holtbrügge , D. ( 2015 ), “ Expatriate performance in terrorism-endangered countries: the role of family and organizational support ”, International Business Review , Vol. 24 No. 5 , pp. 849 - 860 .

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The Philippines economy in 2024: Stronger for longer?

The Philippines ended 2023 on a high note, being the fastest growing economy across Southeast Asia with a growth rate of 5.6 percent—just shy of the government's target of 6.0 to 7.0 percent. 1 “National accounts,” Philippine Statistics Authority, January 31, 2024; "Philippine economic updates,” Bangko Sentral ng Pilipinas, November 16, 2023. Should projections hold, the Philippines is expected to, once again, show significant growth in 2024, demonstrating its resilience despite various global economic pressures (Exhibit 1). 2 “Economic forecast 2024,” International Monetary Fund, November 1, 2023; McKinsey analysis.

The growth in the Philippine economy in 2023 was driven by a resumption in commercial activities, public infrastructure spending, and growth in digital financial services. Most sectors grew, with transportation and storage (13 percent), construction (9 percent), and financial services (9 percent), performing the best (Exhibit 2). 3 “National accounts,” Philippine Statistics Authority, January 31, 2024. While the country's trade deficit narrowed in 2023, it remains elevated at $52 billion due to slowing global demand and geopolitical uncertainties. 4 “Highlights of the Philippine export and import statistics,” Philippine Statistics Authority, January 28, 2024. Looking ahead to 2024, the current economic forecast for the Philippines projects a GDP growth of between 5 and 6 percent.

Inflation rates are expected to temper between 3.2 and 3.6 percent in 2024 after ending 2023 at 6.0 percent, above the 2.0 to 4.0 percent target range set by the government. 5 “Nomura downgrades Philippine 2024 growth forecast,” Nomura, September 11, 2023; “IMF raises Philippine growth rate forecast,” International Monetary Fund, July 16, 2023.

For the purposes of this article, most of the statistics used for our analysis have come from a common thread of sources. These include the Central Bank of the Philippines (Bangko Sentral ng Pilipinas); the Department of Energy Philippines; the IT and Business Process Association of the Philippines (IBPAP); and the Philippines Statistics Authority.

The state of the Philippine economy across seven major sectors and themes

In the article, we explore the 2024 outlook for seven key sectors and themes, what may affect each of them in the coming year, and what could potentially unlock continued growth.

Financial services

The recovery of the financial services sector appears on track as year-on-year growth rates stabilize. 6 Philippines Statistics Authority, November 2023; McKinsey in partnership with Oxford Economics, November 2023. In 2024, this sector will likely continue to grow, though at a slower pace of about 5 percent.

Financial inclusion and digitalization are contributing to growth in this sector in 2024, even if new challenges emerge. Various factors are expected to impact this sector:

• Inclusive finance: Bangko Sentral ng Pilipinas continues to invest in financial inclusion initiatives. For example, basic deposit accounts (BDAs) reached $22 million in 2023 and banking penetration improved, with the proportion of adults with formal bank accounts increasing from 29 percent in 2019 to 56 percent in 2021. 7 “Financial inclusion dashboard: First quarter 2023,” Bangko Sentral ng Pilipinas, February 6, 2024.
• Digital adoption: Digital channels are expected to continue to grow, with data showing that 60 percent of adults who have a mobile phone and internet access have done a digital financial transaction. 8 “Financial inclusion dashboard: First quarter 2023,” Bangko Sentral ng Pilipinas, February 6, 2024. Businesses in this sector, however, will need to remain vigilant in navigating cybersecurity and fraud risks.
• Unsecured lending growth: Growth in unsecured lending is expected to continue, but at a slower pace than the past two to three years. For example, unsecured retail lending for the banking system alone grew by 27 percent annually from 2020 to 2022. 9 “Loan accounts: As of first quarter 2023,” Bangko Sentral ng Pilipinas, February 6, 2024; "Global banking pools,” McKinsey, November 2023. Businesses in this field are, however, expected to recalibrate their risk profiling models as segments with high nonperforming loans emerge.
• High interest rates: Key interest rates are expected to decline in the second half of 2024, creating more accommodating borrowing conditions that could boost wholesale and corporate loans.

Supportive frameworks have a pivotal role to play in unlocking growth in this sector to meet the ever-increasing demand from the financially underserved. For example, financial literacy programs and easier-to-access accounts—such as BDAs—are some measures that can help widen market access to financial services. Continued efforts are being made to build an open finance framework that could serve the needs of the unbanked population, as well as a unified credit scoring mechanism to increase the ability of historically under-financed segments, such as small and medium-sized enterprises (SMEs), to access formal credit. 10 “BSP launches credit scoring model,” Bangko Sentral ng Pilipinas, April 26, 2023.

Energy and Power

The outlook for the energy sector seems positive, with the potential to grow by 7 percent in 2024 as the country focuses on renewable energy generation. 11 McKinsey analysis based on input from industry experts. Currently, stakeholders are focused on increasing energy security, particularly on importing liquefied natural gas (LNG) to meet power plants’ requirements as production in one of the country’s main sources of natural gas, the Malampaya gas field, declines. 12 Myrna M. Velasco, “Malampaya gas field prod’n declines steeply in 2021,” Manila Bulletin , July 9, 2022. High global inflation and the fact that the Philippines is a net fuel importer are impacting electricity prices and the build-out of planned renewable energy projects. Recent regulatory moves to remove foreign ownership limits on exploration, development, and utilization of renewable energy resources could possibly accelerate growth in the country’s energy and power sector. 13 “RA 11659,” Department of Energy Philippines, June 8, 2023.

Gas, renewables, and transmission are potential growth drivers for the sector. Upgrading power grids so that they become more flexible and better able to cope with the intermittent electricity supply that comes with renewables will be critical as the sector pivots toward renewable energy. A recent coal moratorium may position natural gas as a transition fuel—this could stimulate exploration and production investments for new, indigenous natural gas fields, gas pipeline infrastructure, and LNG import terminal projects. 14 Philippine energy plan 2020–2040, Department of Energy Philippines, June 10, 2022; Power development plan 2020–2040 , Department of Energy Philippines, 2021. The increasing momentum of green energy auctions could facilitate the development of renewables at scale, as the country targets 35 percent share of renewables by 2030. 15 Power development plan 2020–2040 , 2022.

Growth in the healthcare industry may slow to 2.8 percent in 2024, while pharmaceuticals manufacturing is expected to rebound with 5.2 percent growth in 2024. 16 McKinsey analysis in partnership with Oxford Economics.

Healthcare demand could grow, although the quality of care may be strained as the health worker shortage is projected to increase over the next five years. 17 McKinsey analysis. The supply-and-demand gap in nursing alone is forecast to reach a shortage of approximately 90,000 nurses by 2028. 18 McKinsey analysis. Another compounding factor straining healthcare is the higher than anticipated benefit utilization and rising healthcare costs, which, while helping to meet people's healthcare budgets, may continue to drive down profitability for health insurers.

Meanwhile, pharmaceutical companies are feeling varying effects of people becoming increasingly health conscious. Consumers are using more over the counter (OTC) medication and placing more beneficial value on organic health products, such as vitamins and supplements made from natural ingredients, which could impact demand for prescription drugs. 19 “Consumer health in the Philippines 2023,” Euromonitor, October 2023.

Businesses operating in this field may end up benefiting from universal healthcare policies. If initiatives are implemented that integrate healthcare systems, rationalize copayments, attract and retain talent, and incentivize investments, they could potentially help to strengthen healthcare provision and quality.

Businesses may also need to navigate an increasingly complex landscape of diverse health needs, digitization, and price controls. Digital and data transformations are being seen to facilitate improvements in healthcare delivery and access, with leading digital health apps getting more than one million downloads. 20 Google Play Store, September 27, 2023. Digitization may create an opportunity to develop healthcare ecosystems that unify touchpoints along the patient journey and provide offline-to-online care, as well as potentially realizing cost efficiencies.

Consumer and retail

Growth in the retail and wholesale trade and consumer goods sectors is projected to remain stable in 2024, at 4 percent and 5 percent, respectively.

Inflation, however, continues to put consumers under pressure. While inflation rates may fall—predicted to reach 4 percent in 2024—commodity prices may still remain elevated in the near term, a top concern for Filipinos. 21 “IMF raises Philippine growth forecast,” July 26, 2023; “Nomura downgrades Philippines 2024 growth forecast,” September 11, 2023. In response to challenging economic conditions, 92 percent of consumers have changed their shopping behaviors, and approximately 50 percent indicate that they are switching brands or retail providers in seek of promotions and better prices. 22 “Philippines consumer pulse survey, 2023,” McKinsey, November 2023.

Online shopping has become entrenched in Filipino consumers, as they find that they get access to a wider range of products, can compare prices more easily, and can shop with more convenience. For example, a McKinsey Philippines consumer sentiment survey in 2023 found that 80 percent of respondents, on average, use online and omnichannel to purchase footwear, toys, baby supplies, apparel, and accessories. To capture the opportunity that this shift in Filipino consumer preferences brings and to unlock growth in this sector, retail organizations could turn to omnichannel strategies to seamlessly integrate online and offline channels. Businesses may need to explore investments that increase resilience across the supply chain, alongside researching and developing new products that serve emerging consumer preferences, such as that for natural ingredients and sustainable sources.

Manufacturing

Manufacturing is a key contributor to the Philippine economy, contributing approximately 19 percent of GDP in 2022, employing about 7 percent of the country’s labor force, and growing in line with GDP at approximately 6 percent between 2023 and 2024. 23 McKinsey analysis based on input from industry experts.

Some changes could be seen in 2024 that might affect the sector moving forward. The focus toward building resilient supply chains and increasing self-sufficiency is growing. The Philippines also is likely to benefit from increasing regional trade, as well as the emerging trend of nearshoring or onshoring as countries seek to make their supply chains more resilient. With semiconductors driving approximately 45 percent of Philippine exports, the transfer of knowledge and technology, as well as the development of STEM capabilities, could help attract investments into the sector and increase the relevance of the country as a manufacturing hub. 24 McKinsey analysis based on input from industry experts.

To secure growth, public and private sector support could bolster investments in R&D and upskill the labor force. In addition, strategies to attract investment may be integral to the further development of supply chain infrastructure and manufacturing bases. Government programs to enable digital transformation and R&D, along with a strategic approach to upskilling the labor force, could help boost industry innovation in line with Industry 4.0 demand. 25 Industry 4.0 is also referred to as the Fourth Industrial Revolution. Priority products to which manufacturing industries could pivot include more complex, higher value chain electronic components in the semiconductor segment; generic OTC drugs and nature-based pharmaceuticals in the pharmaceutical sector; and, for green industries, products such as EVs, batteries, solar panels, and biomass production.

Information technology business process outsourcing

The information technology business process outsourcing (IT-BPO) sector is on track to reach its long-term targets, with $38 billion in forecast revenues in 2024. 26 Khriscielle Yalao, “WHF flexibility key to achieving growth targets—IBPAP,” Manila Bulletin , January 23, 2024. Emerging innovations in service delivery and work models are being observed, which could drive further growth in the sector.

The industry continues to outperform headcount and revenue targets, shaping its position as a country leader for employment and services. 27 McKinsey analysis based in input from industry experts. Demand from global companies for offshoring is expected to increase, due to cost containment strategies and preference for Philippine IT-BPO providers. New work setups continue to emerge, ranging from remote-first to office-first, which could translate to potential net benefits. These include a 10 to 30 percent increase in employee retention; a three- to four-hour reduction in commute times; an increase in enabled talent of 350,000; and a potential reduction in greenhouse gas emissions of 1.4 to 1.5 million tons of CO 2 per year. 28 McKinsey analysis based in input from industry experts. It is becoming increasingly more important that the IT-BPO sector adapts to new technologies as businesses begin to harness automation and generative AI (gen AI) to unlock productivity.

Talent and technology are clear areas where growth in this sector can be unlocked. The growing complexity of offshoring requirements necessitates building a proper talent hub to help bridge employee gaps and better match local talent to employers’ needs. Businesses in the industry could explore developing facilities and digital infrastructure to enable industry expansion outside the metros, especially in future “digital cities” nationwide. Introducing new service areas could capture latent demand from existing clients with evolving needs as well as unserved clients. BPO centers could explore the potential of offering higher-value services by cultivating technology-focused capabilities, such as using gen AI to unlock revenue, deliver sales excellence, and reduce general administrative costs.

Sustainability

The Philippines is considered to be the fourth most vulnerable country to climate change in the world as, due to its geographic location, the country has a higher risk of exposure to natural disasters, such as rising sea levels. 29 “The Philippines has been ranked the fourth most vulnerable country to climate change,” Global Climate Risk Index, January 2021. Approximately $3.2 billion, on average, in economic loss could occur annually because of natural disasters over the next five decades, translating to up to 7 to 8 percent of the country’s nominal GDP. 30 “The Philippines has been ranked the fourth most vulnerable country to climate change,” Global Climate Risk Index, January 2021.

The Philippines could capitalize on five green growth opportunities to operate in global value chains and catalyze growth for the nation:

• Renewable energy: The country could aim to generate 50 percent of its energy from renewables by 2040, building on its high renewable energy potential and the declining cost of producing renewable energy.
• Solar photovoltaic (PV) manufacturing: More than a twofold increase in annual output from 2023 to 2030 could be achieved, enabled by lower production costs.
• Battery production: The Philippines could aim for a $1.5 billion domestic market by 2030, capitalizing on its vast nickel reserves (the second largest globally). 31 “MineSpans,” McKinsey, November 2023.
• Electric mobility: Electric vehicles could account for 15 percent of the country’s vehicle sales by 2030 (from less than 1 percent currently), driven by incentives, local distribution, and charging infrastructure. 32 McKinsey analysis based on input from industry experts.
• Nature-based solutions: The country’s largely untapped total abatement potential could reach up to 200 to 300 metric tons of CO 2 , enabled by its biodiversity and strong demand.

The Philippine economy: Three scenarios for growth

Having grown faster than other economies in Southeast Asia in 2023 to end the year with 5.6 percent growth, the Philippines can expect a similarly healthy growth outlook for 2024. Based on our analysis, there are three potential scenarios for the country’s growth. 33 McKinsey analysis in partnership with Oxford Economics.

Slower growth: The first scenario projects GDP growth of 4.8 percent if there are challenging conditions—such as declining trade and accelerated inflation—which could keep key policy rates high at about 6.5 percent and dampen private consumption, leading to slower long-term growth.

Soft landing: The second scenario projects GDP growth of 5.2 percent if inflation moderates and global conditions turn out to be largely favorable due to a stable investment environment and regional trade demand.

Accelerated growth: In the third scenario, GDP growth is projected to reach 6.1 percent if inflation slows and public policies accommodate aspects such as loosening key policy rates and offering incentive programs to boost productivity.

Focusing on factors that could unlock growth in its seven critical sectors and themes, while adapting to the macro-economic scenario that plays out, would allow the Philippines to materialize its growth potential in 2024 and take steps towards achieving longer-term, sustainable economic growth.

Jon Canto is a partner in McKinsey’s Manila office, where Frauke Renz is an associate partner, and Vicah Villanueva is a consultant.

The authors wish to thank Charlene Chua, Charlie del Rosario, Ryan delos Reyes, Debadrita Dhara, Evelyn C. Fong, Krzysztof Kwiatkowski, Frances Lee, Aaron Ong, and Liane Tan for their contributions to this article.

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