Principles of Corporate Finance_ 12th Edition

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724 Part Eight Risk Management


bre44380_ch27_707-731.indd 724 09/30/15 12:10 PM


from 20% to 50%? Or simply takes over the mine “with fair compensation to be determined in
due course by the Minister of Natural Resources of the Republic of Costaguana”?
No contract can absolutely restrain sovereign power. But you can arrange project financing to
make these acts as painful as possible for the foreign government. For example, you might set
up the mine as a subsidiary corporation, which then borrows a large fraction of the required
investment from a consortium of major international banks. If your firm guarantees the loan,
make sure the guarantee stands only if the Costaguanan government honors its contract. The
government will be reluctant to break the contract if that causes a default on the loans and
undercuts the country’s credit standing with the international banking system.
If possible, you should arrange for the World Bank (or one of its affiliates) to finance part
of the project or to guarantee your loans against political risk.^24 Few governments have the
guts to take on the World Bank. Here is another variation on the same theme. Arrange to bor-
row, say, $450 million through the Costaguanan Development Agency. In other words, the
development agency borrows in international capital markets and relends to the San Tomé
mine. Your firm agrees to stand behind the loan as long as the government keeps its promises.
If it does keep them, the loan is your liability. If not, the loan is its liability.
Political risk is not confined to the risk of expropriation. Multinational companies are
always exposed to the criticism that they siphon funds out of countries in which they do

Maximum score 100
Country Total Rank
Norway 90.8 1
Switzerland 89.5 2
Singapore 87.3 3 = 
Germany 85.3 6
Sweden 84.5 7
Canada 82.3 11
Korea, Republic 81.8 13
Japan 81.0 17
Australia 78.0 24
United Kingdom 76.5 30
United States 75.5 31 = 
China 73.3 41 = 
Italy 70.8 56 = 
France 70.5 58 = 
Russia 70.0 60 = 
Brazil 68.8 67 = 
Argentina 67.0 81 = 
India 65.8 86
Greece 65.0 89 = 
Turkey 59.0 124
Venezuela 54.8 132
Somalia 37.5 140
Note: = denote a tie

❱ TABLE 27.4^ Political risk scores
for a sample of countries, 2014.
Source: International Country Risk Guide, a publication
of The PRS Group, Inc. (www.prsgroup.com), 2014.

(^24) In the appendix to Chapter 24 we described how the World Bank provided the Hubco power project with a guarantee against political risk.

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