benjamin graham university of southern california ipes 2012...factor analysis political risk...

Political Risk and Experience:The Effect of Prior Experience on Firms’ Political Risk Sensitivity

Benjamin GrahamUniversity of Southern California

IPES 2012

Political Risk and Experience Benjamin Graham

Puzzles

Political Risk Experience Benjamin Graham

Puzzles

1. What makes some firms more willing than others to enter countries with high levels of political risk?

Political Risk Experience Benjamin Graham

Puzzles

1. What makes some firms more willing than others to enter countries with high levels of political risk?

2. Are some types of political risk more amenable to active management than others?

Political Risk Experience Benjamin Graham

Answers

Political Risk Experience Benjamin Graham

Answers

• Simple Answers:• Large firms are better able to actively manage risks• Firms in some sectors (e.g. natural resources) are more risk

tolerant

Political Risk Experience Benjamin Graham

Answers

• Simple Answers:• Large firms are better able to actively manage risks• Firms in some sectors (e.g. natural resources) are more risk

tolerant• Interesting Answers:

• Managing risk is something firms learn to do (experience matters)

• This works for some risks (bureaucratic risk) and not for others (policy risk; risk of war and political violence).

Political Risk Experience Benjamin Graham

A 3-Part Typology of Political Risk

• Bureaucratic Risk• Risks related to low bureaucratic quality• Measures: corruption, efficiency of civil courts, customs

efficiency

Political Risk Experience Benjamin Graham

A 3-Part Typology of Political Risk

• Policy Risk• Policy instability and opportunistic behavior by national-level

policymakers• Measures: executive constraints and electoral accountability

Political Risk Experience Benjamin Graham

A 3-Part Typology of Political Risk

• Risk of War and Political Violence• Civil war, interstate war, and one-sided government violence• Measures: current conflict, internal and external war risk,

physical integrity rights violations

Political Risk Experience Benjamin Graham

Factor Analysis

Political Risk Experience Benjamin Graham

Table 1: Types of Political Risk: Factor Loadings for Three Primary Factors

Bureaucratic

Risk Policy Risk

War and Violence

Uniqueness

Corruption (TI) 0.83 0.30 0.26 0.10 Corruption (ICRG) 0.76 0.24 0.19 0.26 Contract Enforcement Costs (DBI) 0.43 -0.06 0.03 0.78 Contract Enforcement Delays (DBI) 0.27 -0.12 0.31 0.68 Trade Delays (DBI) 0.86 0.22 0.13 0.18 Trade Cost (DBI) 0.59 0.02 0.00 0.49 Political Constraints (Henisz) 0.22 0.70 0.07 0.45 Executive Constraints (Polity) 0.25 0.86 0.09 0.17 Political Competition (Polity) 0.16 0.85 0.08 0.25 External War Risk (ICRG) 0.13 0.15 0.42 0.64 Internal War Risk (ICRG) 0.37 0.17 0.69 0.34 Current War (PITF) 0.05 -0.08 0.65 0.55 Physical Integrity Violations (CIRI) 0.38 0.36 0.63 0.30 !

Theory

• Learning and survival• Learning: Firms develop skills to manage the risks they face• Survival: If a firm can’t manage the risks it faces, there will be no

survival, no expansion

Political Risk Experience Benjamin Graham

Theory (2)

Political Risk Experience Benjamin Graham

Theory (2)

• Capabilities for managing bureaucratic risk are transferable across countries• Active use of social networks in business, ability to translate

bribes into results

Political Risk Experience Benjamin Graham

Theory (2)

• Capabilities for managing bureaucratic risk are transferable across countries• Active use of social networks in business, ability to translate

bribes into results• Policy risk (risk from national-level policymakers) is hard for

individual firms to mitigate effectively

Political Risk Experience Benjamin Graham

Theory (2)

• Capabilities for managing bureaucratic risk are transferable across countries• Active use of social networks in business, ability to translate

bribes into results• Policy risk (risk from national-level policymakers) is hard for

individual firms to mitigate effectively• Risk of war & political violence is both unpredictable and difficult to

mitigate• Use of violence is off the equilibrium path

Political Risk Experience Benjamin Graham

Empirical Strategy

Political Risk Experience Benjamin Graham

Empirical Strategy

• Unit = firm entry• New entries only

Political Risk Experience Benjamin Graham

Empirical Strategy

• Unit = firm entry• New entries only

• DV: level of risk in newly entered country

Political Risk Experience Benjamin Graham

Empirical Strategy

• Unit = firm entry• New entries only

• DV: level of risk in newly entered country• IV of Interest: average level of risk faced by other affiliates in year

t-1

Political Risk Experience Benjamin Graham

Empirical Strategy

• Unit = firm entry• New entries only

• DV: level of risk in newly entered country• IV of Interest: average level of risk faced by other affiliates in year

t-1• Controls: GDP per capita (mean), education (mean), size of parent

firm, previous experience, sector dummies, year dummies• Also control for experience with other risk types

Political Risk Experience Benjamin Graham

Empirical Strategy

• Unit = firm entry• New entries only

• DV: level of risk in newly entered country• IV of Interest: average level of risk faced by other affiliates in year

t-1• Controls: GDP per capita (mean), education (mean), size of parent

firm, previous experience, sector dummies, year dummies• Also control for experience with other risk types

• Multilevel model (country level, parent-firm level)

Political Risk Experience Benjamin Graham

Data: The U.S. Bureau of Economic Analysis

Political Risk Experience Benjamin Graham

Data: The U.S. Bureau of Economic Analysis

• The full universe of U.S. outward FDI (2000-2009)• All U.S.-based MNCs and their foreign affiliates• Info on parents and affiliates

Political Risk Experience Benjamin Graham

Data: The U.S. Bureau of Economic Analysis

• The full universe of U.S. outward FDI (2000-2009)• All U.S.-based MNCs and their foreign affiliates• Info on parents and affiliates

• Mandatory response

Political Risk Experience Benjamin Graham

Data: The U.S. Bureau of Economic Analysis

• The full universe of U.S. outward FDI (2000-2009)• All U.S.-based MNCs and their foreign affiliates• Info on parents and affiliates

• Mandatory response• Confidential data

Political Risk Experience Benjamin Graham

Political Risk Experience Benjamin Graham

Empirical ResultsPredicting*The*Level*of*Risk*in*Newly*Entered*Host*Countries*

*! DV!=!Bureaucratic!Risk!in!New!

Host!Country!

DV!=!Policy!Risk!in!New!Host!

Country!

DV!=!Risk!of!War!&!Political!

Violence!in!New!Host!Country!

! (1)! (2)! (3)! (4)! (5)! (6)! (7)! (8)! (9)! (10)! (11)! (12)!

Bureaucratic!Risk!

(mean)!+**! +**! ! +! ! +! ! +! ! +! ! − !

Policy!Risk!

(mean)!

! +! * +! − ! − ! ! +! ! +! ! − !Risk!of!War!&!Pol.!Violence!(mean)!

! −*! ! − ! ! − ! ! − ! +! − ! ! − !GDP!Per!Capita!

(mean)!

! ! −*! − ! ! ! − ! +**! ! ! − ! − !Education!(mean)! ! ! +! +! ! ! +! − ! ! ! − ! − !Parent!Experience!! ! ! +***! +***! ! ! +! +! ! ! +! +!Parent!size!! ! ! +**! +***! ! ! +! +! ! ! +! +!Oil/Mining!Sector! ! +**! ! − ! ! +***! ! +***! ! +***! ! +***!Year!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

Sector!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

! ! ! ! ! ! ! ! ! ! ! ! !

Number!of!

Observations!

567! 544! 566! 543! 567! 544! 566! 543! 567! 544! 566! 543!

RYsquared! 0.011! 0.099! 0.073! 0.164! 0.000! 0.057! 0.006! 0.068! 0.001! 0.066! 0.016! 0.075!

!

Political Risk Experience Benjamin Graham

Empirical ResultsPredicting*The*Level*of*Risk*in*Newly*Entered*Host*Countries*

*! DV!=!Bureaucratic!Risk!in!New!

Host!Country!

DV!=!Policy!Risk!in!New!Host!

Country!

DV!=!Risk!of!War!&!Political!

Violence!in!New!Host!Country!

! (1)! (2)! (3)! (4)! (5)! (6)! (7)! (8)! (9)! (10)! (11)! (12)!

Bureaucratic!Risk!

(mean)!+**! +**! ! +! ! +! ! +! ! +! ! − !

Policy!Risk!

(mean)!

! +! * +! − ! − ! ! +! ! +! ! − !Risk!of!War!&!Pol.!Violence!(mean)!

! −*! ! − ! ! − ! ! − ! +! − ! ! − !GDP!Per!Capita!

(mean)!

! ! −*! − ! ! ! − ! +**! ! ! − ! − !Education!(mean)! ! ! +! +! ! ! +! − ! ! ! − ! − !Parent!Experience!! ! ! +***! +***! ! ! +! +! ! ! +! +!Parent!size!! ! ! +**! +***! ! ! +! +! ! ! +! +!Oil/Mining!Sector! ! +**! ! − ! ! +***! ! +***! ! +***! ! +***!Year!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

Sector!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

! ! ! ! ! ! ! ! ! ! ! ! !

Number!of!

Observations!

567! 544! 566! 543! 567! 544! 566! 543! 567! 544! 566! 543!

RYsquared! 0.011! 0.099! 0.073! 0.164! 0.000! 0.057! 0.006! 0.068! 0.001! 0.066! 0.016! 0.075!

!

Political Risk Experience Benjamin Graham

Empirical ResultsPredicting*The*Level*of*Risk*in*Newly*Entered*Host*Countries*

*! DV!=!Bureaucratic!Risk!in!New!

Host!Country!

DV!=!Policy!Risk!in!New!Host!

Country!

DV!=!Risk!of!War!&!Political!

Violence!in!New!Host!Country!

! (1)! (2)! (3)! (4)! (5)! (6)! (7)! (8)! (9)! (10)! (11)! (12)!

Bureaucratic!Risk!

(mean)!+**! +**! ! +! ! +! ! +! ! +! ! − !

Policy!Risk!

(mean)!

! +! * +! − ! − ! ! +! ! +! ! − !Risk!of!War!&!Pol.!Violence!(mean)!

! −*! ! − ! ! − ! ! − ! +! − ! ! − !GDP!Per!Capita!

(mean)!

! ! −*! − ! ! ! − ! +**! ! ! − ! − !Education!(mean)! ! ! +! +! ! ! +! − ! ! ! − ! − !Parent!Experience!! ! ! +***! +***! ! ! +! +! ! ! +! +!Parent!size!! ! ! +**! +***! ! ! +! +! ! ! +! +!Oil/Mining!Sector! ! +**! ! − ! ! +***! ! +***! ! +***! ! +***!Year!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

Sector!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

! ! ! ! ! ! ! ! ! ! ! ! !

Number!of!

Observations!

567! 544! 566! 543! 567! 544! 566! 543! 567! 544! 566! 543!

RYsquared! 0.011! 0.099! 0.073! 0.164! 0.000! 0.057! 0.006! 0.068! 0.001! 0.066! 0.016! 0.075!

!

Political Risk Experience Benjamin Graham

Empirical ResultsPredicting*The*Level*of*Risk*in*Newly*Entered*Host*Countries*

*! DV!=!Bureaucratic!Risk!in!New!

Host!Country!

DV!=!Policy!Risk!in!New!Host!

Country!

DV!=!Risk!of!War!&!Political!

Violence!in!New!Host!Country!

! (1)! (2)! (3)! (4)! (5)! (6)! (7)! (8)! (9)! (10)! (11)! (12)!

Bureaucratic!Risk!

(mean)!+**! +**! ! +! ! +! ! +! ! +! ! − !

Policy!Risk!

(mean)!

! +! * +! − ! − ! ! +! ! +! ! − !Risk!of!War!&!Pol.!Violence!(mean)!

! −*! ! − ! ! − ! ! − ! +! − ! ! − !GDP!Per!Capita!

(mean)!

! ! −*! − ! ! ! − ! +**! ! ! − ! − !Education!(mean)! ! ! +! +! ! ! +! − ! ! ! − ! − !Parent!Experience!! ! ! +***! +***! ! ! +! +! ! ! +! +!Parent!size!! ! ! +**! +***! ! ! +! +! ! ! +! +!Oil/Mining!Sector! ! +**! ! − ! ! +***! ! +***! ! +***! ! +***!Year!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

Sector!Dummies! ! YES! ! YES! ! YES! ! YES! ! YES! ! YES!

! ! ! ! ! ! ! ! ! ! ! ! !

Number!of!

Observations!

567! 544! 566! 543! 567! 544! 566! 543! 567! 544! 566! 543!

RYsquared! 0.011! 0.099! 0.073! 0.164! 0.000! 0.057! 0.006! 0.068! 0.001! 0.066! 0.016! 0.075!

!

Takeaways

Political Risk Experience Benjamin Graham

Takeaways

• Experience and firm size are only useful to predict willingness to enter countries with a given level of bureaucratic risk

Political Risk Experience Benjamin Graham

Takeaways

• Experience and firm size are only useful to predict willingness to enter countries with a given level of bureaucratic risk

• Past experience managing bureaucratic risk may or may not be useful

Political Risk Experience Benjamin Graham

Takeaways

• Experience and firm size are only useful to predict willingness to enter countries with a given level of bureaucratic risk

• Past experience managing bureaucratic risk may or may not be useful

• Other than by sector, its hard to predict firms’ tolerance of policy risk or risk of war & political violence

Political Risk Experience Benjamin Graham