20. POLITICAL, COUNTRY, AND GLOBAL SPECIFIC RISKS
Political risk originates from government because a government can impose its authority
over an enterprise's operations within a border or even outside its borders. Once an international
company or investor establishes a business within a foreign country, the host government
enforces its own laws, rules, regulations, and taxes. Some governments view the foreign
businesses or international investors unfavorably, and they punish the business or expropriate
the business's assets.
This section examines the numerous risks a foreign business or investor could experience,
and predict whether to invest in a particular country. Some countries are pro-business, and
international investors and businesses can invest there with little danger. Unfortunately, other
countries are dangerous because a government can interfere with business investment, impose
excessive taxes and regulations, or even nationalize investors' and businesses' assets. Thus, we
examine a country's risk in detail, and the methods the international investors use to minimize
their exposure to a country’s risk level. Furthermore, we study the methods to calculate a
country's risk and the risk premium that we need to compensate investors for the greater
investment risk.
Political, Country, and Global Specific Risks
Political risk comes in many forms. For instance, firm specific risk, also called micro risk,
is a foreign business and the host government encounters a conflict. Different firms experience
distinctive risks. For example, a restaurant chain would experience a different risk level than an
electronics manufacturing company. A restaurant chain leases its space and competes with
numerous local businesses, whereas an electronics manufacturing facility requires billions of
U.S. dollars for investment. Moreover, the officials in a foreign government will know about the
electronics company well, but the restaurant chain may not appear on the government’s radar.
Furthermore, a firm has a currency exchange rate risk, which we discussed in Chapter 19.
Although the exchange rate risk is a firm specific risk, a government does not directly impose
the risk onto a business.
A government and foreign company could experience conflicts over control of key
industries or a foreign company infringes on national sovereignty. For example, a Dubai state-
owned company, Dubai Ports World, wanted to buy six U.S. ports in 2006 that caused a political
uproar in the United States. President Bush wanted to proceed with the deal while Congress
blocked the deal. Although a British company owned the ports, Americans worried about
Dubai's association with the Arab world, and Arab ownership would lead to a rise in terrorism.
Subsequently, Dubai World sold its interest in the ports to an American company, AIG.
A government and foreign company could clash over local interests versus a foreign
company's self-interests. Consequently, a government retains control over its defense industries
and restricts ownership of production for military equipment and supplies. If a government
relied on a foreign country for military supplies, then that foreign country could withhold