Chapter 6: Government, Law, and Political Risk in Types of Political Risk

International Business Let us take a look at the two basic general types of risk:
1. Systematic Risk: A risk that influences a large number of
assets. An example is political events. It is virtually impossible
Introduction
to protect yourself against this type of risk.
Managers in international companies are faced with
2. Unsystematic Risk: Fundamental Risk is the risk that affects a
different political and regulatory systems. The political
large number of assets such as stocks or bonds. Specific Risk
environment provides both opportunities and drawbacks.
is risk that only affects a very small number of asset classes
International managers may face a number of unfamiliar,
such as companies or individuals. particularly when we talk
unfriendly, political environments. They may also find themselves
about stocks and bonds:
in the midst of discriminatory practices in certain countries
around the world.
 Credit or Default Risk: This is the risk that a company or
individual will not be able to pay its debt obligations.
Government bonds have the least default risk and the least
The Political Environment
amount of returns. Corporate bonds tend to have the highest
Proactive international firms maintain an up-to-date
amount of default risk but also the higher interest rates.
profile of the political and economic environment of the countries
in which they maintain operations (or have plans for future  Country Risk: When a country defaults it can harm the
performance of all other financial instruments in that country
investment).
as well as other countries it has relations with. Country risk
applies to stocks, bonds, mutual funds, options, and futures
What Are Political Risks?
that are issued within a particular country.
Political risks are the actions that have the potential to
affect the immediate and/or long-term viability of a firm.
 Foreign Exchange Risk: Foreign Exchange Risk: When investing
in foreign countries, firms must consider the fact that currency
Managers in international companies are faced with different
exchange rates can change the price of the asset as well.
political and regulatory systems. The risk that a country's
Foreign exchange risk applies to all financial instruments that
government will suddenly change its policies is called political
are in a currency other than your domestic currency.
risk. This can range from confiscation of operations to changes in
the tax code. Even experts have trouble making such predictions
 Interest Rate Risk: A rise in interest rates during the term or
debt securities hurts the performance of stocks and bonds.
for their own operations.
 Political Risk: This represents the financial risk that a country’s
government will suddenly change its policies. This is a major
 reason that Second and Third World countries lack foreign
investment.
 Market Risk: This is the most familiar of all risks. It is the day-
to-day fluctuations in a stock’s price. Volatility is a measure of
risk because it refers to the behavior, or "temperament," of
your investment rather than the reason for this behavior.
Political/Economic Environment Risk
There are many types of political/economic variables that
could present a risk to conducting business. MNCs should be
aware of the risks associated with nationalization and
confiscation. Civil war and terrorism represent a greater business
risk for an MNC today than they have for some time.
Domestic Economic Conditions
Risk factors include the ability of a country to purchase a
company's products and the presence of infrastructure (such as
roads, airports, and other transportation systems).
External Economic Relations as Risk Factors
Every country restricts its external economic relations in
several ways, including by imposing tariffs and banning imports.
One nation may wish to limit imports in order to force other
countries to open their markets. A country may also restrict
imports when they are perceived to be a threat to the health or
safety of its citizens.
The Legal Environment
The laws of both the home and the host countries can
affect directly and indirectly the international companies and the
way they conduct their business. International firms must
consider the overall international political and legal environment.
Although there is no body to enforce international law, certain
treaties and agreements are respected by a number of countries
and influence international business operations.
Resolving International Disputes
There is considerable trade and legal disagreement among
countries, and resolving disputes across borders is very complex.
Partly, this is because a trade conflict might be treated differently
by international and domestic laws.
Source of Jurisdiction
Over 2100 people died and nearly 200,000 were injured in the
1984 Bhopal disaster. Union Carbide (US) reached an agreement
with the Indian Supreme Court to pay $480 million to the victims.
It is difficult to decide which country's courts and laws apply in
any one situation.
The Political Environment
International firms maintain an up-to-date profile of the
political and economic environment of the countries they operate
in. Managers must understand the ethnic and religious
composition of the host country in order to anticipate problems
of a general instability.
The Legal Environment
Closely related to the political system, the legal system is
another Managers must be aware of the legal systems in the
countries in which they operate. Legal systems include common corruption. The ability to effectively practice risk management will
law, civil law and theocratic law. Some totalitarian countries do determine the success of international firms now and in the
not have a legal system in place that deals with business future.
transactions in a global market context.

Common Law
The United States and the United Kingdom are examples
of countries with a common law system. Common law is based
on tradition, precedent, and custom and usage. The courts fulfill
an important role by interpreting the law according to these
characteristics.

Civil Law
A civil law system is based on a detailed set of laws
organized into a legal code. In a common law system the judge
serves as a neutral referee, ruling on various motions by the
opposing parties' lawyers.

Theocratic Law
This law is based on the officially established rules
governing the faith and practice of a particular religion. A country
that applies religious law to civil and criminal conduct is called a
theocracy. How to preserve the personal security of employees
has gained new prominence in corporate strategies.

Government Issues and Corruption

Corruption erodes respect for the law and deters honest people
from entering public service. International financial institutions
may reduce or eliminate aid if a country has high levels of