International Business

Legal Forces
Lecture 3
 Overview
• Introduction
• The Legal Environment
– Differences in Legal Systems
– Domestically Oriented Laws
– Laws Directly Affecting IB Transactions
– Laws Directed Against Foreign Firms
– The Impact of MNCs on Host Countries
– Dispute Resolution in IB

2
 Introduction
• Virtually, all decisions facing international
managers are affected by the national
environment of the country in which the
transaction occurs
– Whom to hire?
– How to market the company’s goods in
the host market?
– Which technology to adopt?
3
 Introduction
• In developing a strategy for entering a
specific market, a company has to confront
cultural, legal, and political issues unique to
the host country
– Known examples?
• The aim is to understand the impact of the
various dimensions of a country’s
environment on the management of a firm’s
international business
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 The Legal Environment
• A domestic firm must follow the laws and
customs of its home country
• An international business faces a more
complex task
• It must obey the laws not only of its home
country but also the laws of all the host
countries in which it operates

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 The Legal Environment
• Both home and host country laws can
critically affect the way international firms
conduct their business
• These laws determine:
– The markets firm serve
– The prices they can charge for their
goods
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 The Legal Environment
– The cost for necessary inputs such as
labour, raw materials, and technology
– The location of the economic activity
• Known examples of Internet companies?
– Operations in US
– Operations in China

7
 Differences in Legal Systems
• National legal systems vary dramatically for
historical, cultural, political and religious
reasons
• The rule of the law, the role of lawyers, the
burden of proof, the right to judicial review,
and the laws themselves vary from country
to country
– Examples: laying off workers in US and
Belgium
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 Differences in Legal Systems

• Access to the legal system may also vary

from country to country
– US: easy availability of lawyers and non-
discriminatory access to its legal system
are helpful to international businesses
wishing to settle disputes with suppliers
and customers

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 Differences in Legal Systems

– South Korea: suffers a shortage of

lawyers; why?; thus, many international
businesses are forced to resolve disputes
privately rather than utilize South Korean
courts

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 Differences in Legal Systems

• Indian court system has a backlog of over 3

million cases, many attorneys advise their
business to settle conflicts out of court
rather than wait as long as 10 years to be
heard in a court of law
• Portugal: civil suits can take 12 years to
traverse its court

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 Common Law

• Common law is the foundation of the legal

systems in UK and its former colonies;
including US, Canada, Australia, India,
New Zealand etc.
• Common law is based on the cumulative
wisdom of judges’ decisions on individual
cases through history; these cases create
legal precedents
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 Common Law

• Common law has evolved differently in

each common law country
• Thus, laws affecting business practices vary
somewhat among these countries, creating
problems for the uninformed international
business person

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 Common Law

• Manufacturers of defective products are

more vulnerable to lawsuits in the US than
in UK as a result of evolutionary
differences in the two countries’ case law
• In addition to evolutionary differences in
case law, statutory laws, those enacted by
legislative action, also vary among the
common law countries

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 Common Law

• Many business transactions between firms

and the British government are shielded
from public scrutiny and competitors, by
Britain’s Official Secrets Act
• In contrast, more information about
transactions between firms and the US
federal government is publicly available,
because of the US Freedom of Information
Act
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 Common Law

• Even the administration of law may vary;

examples?

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 Civil Law
• Another form of legal system based on a
codification or detailed listing of what is and
is not permissible
• Originated in the biblical times with the
Romans, who spread it throughout the
western world
• Its dominance was reinforced by the
imposition of the civil-law-based Napoleonic
Code on territories conquered by the French
emperor Napoleon Bonaparte
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 Civil Law

• One important difference between common

law and civil law systems is apparent in the
roles of judges and lawyers
• In a common law system: the judges serve
as neutral referee, ruling on various motions
by the opposing parties’ lawyers

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 Civil Law

• In a civil law system: the judge takes on

many of the tasks of the lawyers,
determining, for example the scope of
evidence to be collected and presented to
court

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 Religious Law

• 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
• In Iran, a group of mullahs, or holy men,
determine legality or illegality through their
interpretation of the Koran, the holy book
of Islam
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 Religious Law

• Religious laws present different situations

to firms
• Teaching of Koran: denounces charging
interest on loans as an unfair exploitation of
the poor

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 Religious Law

• Muslim firms and financial institutions have

had to develop alternative financial
arrangements to acquire and finance capital;
rely on leasing arrangements, rather than
borrowing money, to pay long-term assets

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 Religious Law
• In Iran, banks often charge up-front fees that
act as a substitute for loan interest payments,
and owners of deposits receive shares of
bank’s profits rather than interest payments
• Pakistani banks are adopting similar policies,
referred to as Islamic Banking, because
Pakistan’s Supreme Court issued a ruling in
1999 declaring all interest-bearing
transactions to be contrary to Islamic law

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 Religious Law

• Countries relying on religious law often

have other features, such as an absence of
due process and appeals procedures, which
outsiders should be cautious of
• In Saudi Arabia, all foreign firms must have
a local representative or sponsor, typically a
government agency or a person well
connected to the royal family
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 Religious Law

• In case of commercial dispute: weak

bargaining power
• Examples?

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 Bureaucratic Law

• The legal system in communist countries

and in dictatorships is often described as
bureaucratic law
• Whatever the bureaucrats say it is,
regardless of the formal law of the land
• Contracts can be made or broken at the
whims of those in power

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 Bureaucratic Law

• The collapse of the Zairean dictator Mobuto

Sese Seko’s government in 1997,
threatened the viability of all existing
contracts signed by the foreign companies
and triggered a chaotic situation to
revalidate old contracts and negotiate new
ones with the new government

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 Bureaucratic Law

• Protections that may appear in the country’s

constitution, such as the right to an attorney,
may be ignored if government officials find
them inconvenient
• In countries relying on bureaucratic law, the
ability of an international business to
manage its operations is often compromised
by bureaucrats

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 Bureaucratic Law

• International managers are often confronted

with arbitrary rules or decisions that have
the force of law
• Many international managers realize that an
unfortunate by-product of bureaucratic law
is the lack of consistency, predictability,
and appeal procedures

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 Bureaucratic Law
• International business people must be aware
of the general differences in legal systems
to avoid costly misunderstandings
• They must also rely on the expertise of local
lawyers, in each country in which they
operate, to help them comply with the
specific requirements of local laws and to
counsel them on substantive differences in
due process, legal liabilities, and procedural
safeguards
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 Domestically Oriented Laws
• The laws of the countries in which an
international business operates play a major
role in shaping the opportunities available
to that firm
• Some of these laws are primarily designed
to regulate the domestic economic
environment; such laws affect all the facets
of a firm’s domestic operations:
– Managing its workforce; how?
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 Domestically Oriented Laws

• Financing its operations

– Securities, banking, and credit laws
• Marketing its products
– Advertising, distribution, consumer
protection laws
• Developing and utilizing technology
– Patent, copyright, and trademark laws
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 Domestically Oriented Laws

• Although such laws are primarily focused

on the domestic market place, they may
indirectly affect the ability of domestic
firms to compete internationally by
increasing their costs, thus reducing their
price competitiveness relative to foreign
firms

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 Domestically Oriented Laws
• Example: labour costs in France, Germany are
high due to government-mandated benefits
packages; such firms find their products to be less
price competitive in export markets; focus on
which aspect?
• Domestically oriented laws may also inadvertently
affect the business practices of foreign firms
operating outside the country’s borders

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 Domestically Oriented Laws

• Often firms whose products are geared to

the export market alter their production
techniques to meet the regulations of the
importing countries; even though the firm’s
operations are legal within their home
countries

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 Domestically Oriented Laws

• Example: Grupo Herdez chose to alter its

production processes in Mexico in order to
sell its goods in the US market; meeting the
needs of the US market and complying the
regulatory framework for health and safety
norms

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Laws Directly Affecting IB Transactions

• Other national laws are explicitly designed

to regulate IB activities
• Such laws are often politically motivated
and designed to promote the country’s
foreign policy or military objectives

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Laws Directly Affecting IB Transactions

• A country may attempt to induce a second

country to change an undesirable policy by
imposing sanctions – restraints against
commerce with that country
• Sanctions may take many forms, such as
restricting access to high-technology goods,
withdrawing preferential tariff treatment,
boycotting the country’s goods, and denying
new loans
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Laws Directly Affecting IB Transactions

• UN imposed financial sanctions against

Sierra Leone and Liberia to cut the flow of
arms to the war-torn areas; US levied
sanctions against Sudan for human rights
violations
• An embargo: a comprehensive sanction
against all commerce with a given country;
it may be imposed by countries acting in
unison or alone
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Laws Directly Affecting IB Transactions
• Example: UN embargoed all trade with
Iraq, after Iraq’s 1990 invasion of Kuwait;
case of South Africa in the 1990’s
• A particularly important form of sanction is
export controls on high-technology goods
• Many technologically advanced countries
control the export of so-called dual-use
products that may be used for both civilian
and military purposes
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Laws Directly Affecting IB Transactions

• McDonnell Douglas selling sophisticated

machine tools to the China National Aero-
Technology Import and Export Company;
tools to be used for civilian aircraft, but
used to build ballistic and cruise missiles

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Laws Directly Affecting IB Transactions

• Boeing agreed to pay a $15m fine in 2006

because it sold to China 94 commercial
airliners whose avionics systems contained
a tiny gyrochip that could be used to guide
air-to-surface missiles, without receiving an
export license, in violation of the Arms
Control Export Act

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Laws Directly Affecting IB Transactions

• Countries may also attempt to regulate

business activities that are conducted
outside their borders, a practice known as
extraterritoriality
• For example, firms are vulnerable to US
antitrust lawsuits if they engage in activities
outside the US that diminish competition in
the US market
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Laws Directly Affecting IB Transactions

• US successfully sued Pilkington PLC,

British owner of the most important patents
for producing flat glass; limiting the ability
of the US licensees to use the technology in
international markets; hurting US exports,
reducing incentive for RnD thereby
lessening competition

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Laws Directly Affecting IB Transactions

• The Helms-Burton Act is probably the most

controversial application of
extraterritoriality affecting international
business today
• This act is directed against international
firms that “traffic” in the assets of US
companies that were confiscated by the
Cuban government when Fidel Castro
assumed control in 1959
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Laws Directly Affecting IB Transactions

• Over time, the Cuban government has

leased or sold many of these confiscated
assets to foreign companies
• What does the Helms-Burton Act allow?
– Take legal action against the new foreign
owners

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Laws Directly Affecting IB Transactions

– Deny entrance to the US of officers of

companies that benefit from the use of
these confiscated assets
• How other countries view this Act?

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 Laws Directed Against Foreign Firms
• On other occasions, countries may pass
laws that are explicitly directed against
foreign-owned firms
• Ownership issues are a particular area of
concern
• Political issue: left v.s. right; appropriate
balance between governmental control of
the economy and reliance on market forces
to allocate resources
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 Laws Directed Against Foreign Firms

• Often when leftist governments obtain

power, they choose to transfer ownership of
resources from the private to the public
sector; a process called nationalization
– Who are most vulnerable? Which type of
industries and why?

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 Laws Directed Against Foreign Firms
• Expropriation: governments compensate the
private owners for their losses
• Confiscation: no compensation offered by the
governments
• Many Arab oil-producing countries
nationalized the properties of Western oil
firms after 1973; firms offered a combination
of compensation, continuing operating
agreements, and future drilling rights
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 Laws Directed Against Foreign Firms

• Privatization: the conversion of state-owned

property to privately owned property
• Not strictly an issue of host country control;
it creates opportunities for international
businesses
– Which type of state-owned enterprises
are sold to the private sector? Identify the
characteristics

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 Laws Directed Against Foreign Firms

• Why privatization is of interest to

international businesses?
– Expand the operations into new markets
located in key sectors of a national
economy; telecoms, transportation,
manufacturing

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 Laws Directed Against Foreign Firms

• Privatization gained momentum in the

1980s
– Political ideology
– Economic pressure
• Refer to UK; PM M. Thatcher; 1979-1990
– Diminishing the role of the state in the
economy; government’s interest sold in
BA, BT, BAA, BP
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 Laws Directed Against Foreign Firms
• Competitive pressures that firms face in the
global markets
– Refer to the telecommunications industry;
rapid technological change
– Governments face enormous budgetary
pressures and deficits and find it difficult
to raise the capital required to upgrade and
expand state-owned telecommunications
systems; UK, Argentina, Mexico, Chile
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 Laws Directed Against Foreign Firms

• Constraints on foreign ownership

– Many governments limit foreign
ownership of domestic firms to avoid
having their economies or key industries
controlled by foreigners;
– Mexico: energy industry; national
patrimony

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Laws Directed Against Foreign Firms
– Canada: newspapers; capped foreign
ownership to 25%; why?
– US: radio and TV stations
– Countries can also restrain foreign MNCs by
imposing restrictions on their ability to
repatriate the profits earned in the host
countries
– Such restrictions were common in the
1980s; but were abolished in the 1990s; e.g.
Botswana
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The Impact of MNCs on Host Countries

• Firms establishing operations beyond the

borders of their home country affect and are
affected by the political, economic, social,
and cultural environments of the host
countries, in which the firms operate

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The Impact of MNCs on Host Countries

• To compete effectively in these markets and

maintain productive relationships with the
governments of the host countries,
international managers must recognize how
they and their firms should interact with the
national and local environments

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The Impact of MNCs on Host Countries

• Economic Impact
• MNCs affect every local economy in which
they compete and operate
• Positive effects: Western supermarket
chains entering the Chinese market
– Greater selection, national brands, high
standards of hygiene
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The Impact of MNCs on Host Countries
– Investments in plant and equipment,
factories, job creation, payment of taxes,
technology transfer
• Negative effects: MNCs compete directly
with local firms; loss of jobs and profits
– Local economy becomes more dependent
on the economic health of an MNC;
increasing significance of the financial
fortunes of MNCs
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The Impact of MNCs on Host Countries

– When retrenchment of an MNC is

accompanied by layoffs, cutbacks, or a
total shutdown of local operations, the
effects can be devastating; recent
examples in the EU, US

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The Impact of MNCs on Host Countries

• Political Impact
• May be intentional or unintentional
• Their sheer size gives the firms tremendous
power in the country in which they operate;
misuse of power

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The Impact of MNCs on Host Countries

– Threat to shift production and jobs to

other locations; example of Spain in the
mid 1990s, passing new laws that raised
labour costs; Colgate-Palmolive closed
some factories; effect on unemployment
rate?

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The Impact of MNCs on Host Countries

• Cultural Impact
• MNCs can also exert a major influence on
the cultures in which they operate
• Raise local standards of living, help develop
new norms, standards and behaviors
• Both positive and negative effects

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The Impact of MNCs on Host Countries
• Safer methods of work, better healthcare and
pharmaceuticals
• Nestle introducing and promoting infant
formula in the world’s developing countries
– Mothers buying the formula, but not
adequately trained in its proper use;
diluted same to go further; critics argue,
infant mortality increased significantly in
these countries
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 Dispute Resolution in IB
• Disputes in international commerce can be
very complicated; typical questions to be
answered
– Which country’s law apply?
– In which country should the issue be
resolved?
– Which technique should be used to resolve
the conflict: litigation, arbitration,
mediation, or negotiation?
– How will the settlement be enforced?
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 Dispute Resolution in IB
• Because of the costs and uncertainties of
litigation, many international businesses
seek less expensive means of settling
disputes over international transactions; e.g.
arbitration
• Arbitration: process by which both parties to
a conflict agree to submit their cases to
private individual or body whose decision
they will honor
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 Dispute Resolution in IB
– Because of the speed, privacy, and
informality of such proceedings, disputes
can often be resolved more cheaply than
through the court system; e.g. 5 year old
conflict between IBM and Fujitsu over the
latter’s unauthorized use of proprietary
IBM software that was moving slowly
through the US judicial system was settled
quickly with the help of two neutral
arbitrators
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 Dispute Resolution in IB

• Another set of issues arising when an

international business is in dispute with a
national government
• Limited legal recourse
• Countries often negotiate bilateral treaties
to protect their firms from arbitrary actions
by host governments

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 Dispute Resolution in IB

• Agree to arbitrate investment disputes

involving the host country and citizens of
the other country

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 Questions
• What options do firms have when caught in
conflicts between home country and host
country laws?
• What is the impact of vigorous enforcement
of IPR on the world economy? Who gains
and who loses from the strict enforcement
of these laws?
• How do restrictions on repatriation of
profits affect MNCs?
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