Managing Political Risks Essay

A firm must be able to manage the different kinds of political risks that it may have to face by investing in a particular country. Firm-specific risks are defined as risks that affect the multinational enterprise at the corporate and/or project level. The most consequential firm-specific risk is referred to as the â€Å"governance risk,† which entails that there may be a conflict of goals between the multinational enterprise and the host government (Frenkel, Karmann, and Scholtens 5). Volatility of foreign exchange rates is another example of a firm-specific risk (Frenkel, Karmann, and Scholtens). Country-specific risks must also be managed. These risks affect the multinational enterprise at the corporate and/or project level, too. However, the difference between firm-specific and country-specific risks is that the latter originate at the level of the country. Institutional and/or cultural risks in addition to â€Å"transfer risks† are examples of country-specific risks (Frenkel, Karmann, and Scholtens 6). While the latter involves the issue of â€Å"blocked funds,† the former involves problems such as corruption in the country where the multinational enterprise intends to invest its funds (Frenkel, Karmann, and Scholtens 6). Lastly, the multinational enterprise must seek to manage its global-specific risks. These risks affect the enterprise at the corporate and/or project level but originate at the level of the entire globe. Poverty and terrorism are examples of global-specific risks (Frenkel, Karmann, and Scholtens). Indeed, it is possible for the multinational enterprise to manage the three types of political risks. There are three principles methods of political risk management: â€Å"limiting, diversifying, and hedging (Frenkel, Karmann, and Scholtens 20). † The first method refers to the investor’s effort to limit the exposure to the political risk by â€Å"putting a cap on the exposure vis-a-vis a particular country, often as a percentage of overall exposure or own funds (Frenkel, Karmann, and Scholtens 20). † Netting is involved in this procedure, as the investor must calculate the net exposure before â€Å"trying to derive a smaller overall position (Frenkel, Karmann, and Scholtens 20). † Following this political risk management procedure, a parent company may decide to limit the amount of funds that it transfers to its subsidiary that directly faces a particular type of political risk (Frenkel, Karmann, and Scholtens). Diversification is another useful method of managing political risks. A multinational enterprise, when faced with political risks, may decide to spread the exposure among various countries that are not perfectly correlated. If the enterprise is faced with corruption in the countries of two of its subsidiaries, it may choose two more countries where corruption is not a political risk. As a matter of fact, this method of managing political risks tends to be the easiest and therefore most commonly used (Frenkel, Karmann, and Scholtens). Hedging is yet another way to manage political risks, but is typically understood to be possible only with investment and/or export insurance. As an example, the multinational enterprise may obtain such insurance from the Multilateral Investment Guarantee Agency of the World Bank. The insurance may provide covers against civil disturbance, war, expropriation, in addition to currency transfers. National insurance companies – run by the government – may similarly be approached by the investor to obtain cover for risks that arise from non-payment (Frenkel, Karmann, and Scholtens). Regardless of the kinds of political risks facing the investor, therefore, it is possible to invest by managing the risks after choosing one or more methods of political risk management. Works Cited Frenkel, Michael, Alexander Karmann, and Bert Scholtens (eds. ). Sovereign Risk and Financial Crises. New York: Springer-Verlag, 2004.