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