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How Political Risk Affects Infrastructure Investments

How Political Risk Affects Infrastructure Investments

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How Political Risk Affects Infrastructure Investments
Published : November 10, 1999 inKnowledge@Wharton 
Corporations are an opportunistic lot. They are willing to travel to the ends of the earth tomeet a demand for their services, especially in today’s increasingly global economy.Many rapidly industrializing countries around the world lag behind the U.S. ininfrastructure development, which is one reason why companies, particularly utilities, areinvesting in overseas projects. Telecommunications giant AT&T is an example, as isGPU, the Parsippany, N.J.-based energy company that two years ago announced it wasexiting the deregulating generation business to focus on the infrastructure business, or thedistribution of power. A good part of its business is now done overseas in such countriesas Australia and Britain.Infrastructure investment is not as seamless, however, as identifying a need and moving to satisfy it.Investors contemplating overseas investments need to consider the political climate there and its futurestability. If they don’t, the consequences can be financially devastating. "If you’re talking about telecominfrastructure or an electrical generating facility, you could be looking at upwards of a $1 billion or $2 billion investment," explainsWitold J. Henisz, a Wharton School professor and author, along with BennetA. Zelner of the McDonough School of Business at Georgetown University, of the 1999 study, "PoliticalRisk and Infrastructure Investment."Henisz and Zelner are in the midst of a multi-year project in the electric utility industry and will soon betraveling to meet with representatives of GE Capital, Duke Power, Enron, AES and other energycompanies. Next year, they will extend their research with trips to Latin America and East Asia."Infrastructure investments have very long life spans," Henisz continues. "Often, investors do not receivecash or other monetary payments at the time of the transfer of these assets, but they’re involved in somesort of extended financing agreement. In countries where the government’s credibility is called intoquestion, the feasibility and viability of some of these projects are also called into account." Not only potential investors, but also the policymakers in countries that are devising policies to attract investorsneed to be aware of the political relationships that could jeopardize these deals.According to the World Bank, annual spending on infrastructure in developing countries exceeds $200 billion and is expected to grow. But while the potential exists, so too does the risk. A MerchantInternational Group report that surveyed 7,500 multinational corporations found that "84% of operationsinitiated in emerging markets in the past three years have not met their financial targets." Unexpectedrisks cost these companies an estimated $24 billion in 1998.Says Henisz: "Companies are doing the best they can to understand the extent of risks that exist in thesecountries. But they’re still learning about how these political and regulatory systems work. They goabroad and think they have adequate safeguards. Maybe they’ve brought in a local partner that will helpthem deal with the government or they’ve brought in the World Bank to secure part of the loan. Whathappens, though, is that the government is also being strategic and thinking about the best way it can getreelected and stay in power. The new actions they experiment with can lead to diminution in revenue for the overseas firm."Henisz argues that the better investors understand the relationship between political risk and infrastructureinvestment, the more sophisticated their risk analyses will be up-front, thus protecting them from entering potentially money-losing ventures. As investors become more equipped to analyze the risks, policymakers will need to provide investors with credible policy commitments - beyond the simplehandshake and promise of many happy returns.
This is asingle/personal usecopy of Knowledge@Wharton.For multiple copies,custom reprints,e-prints, posters or plaques, pleasecontact PARSInternational:reprints@parsintl.comP. (212) 221-9595x407.
 
All materials copyright of the Wharton School of the University of Pennsylvania. Page 1 of 2
How Political Risk Affects Infrastructure Investments: Knowledge@Wharton (http://knowledge.wharton.upenn.edu/article.cfm?articleid=98)

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