short summery of thesis on local noncommercial risk

8/12/2019 Short Summery of Thesis on Local Noncommercial Risk

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The rise in the number of disputes between local communities and foreign investors in recent yearsis a troubling trend resulting from a failure on the part of firms, specifically foreign multinationalsengaged in the extractive industries, to take into account local political and social-culturalstakeholders. This oversight often leads to local noncommercial risk and a loss of a firms sociallicense to operate. Many firms have attempted to avoid the financial penalties of localnoncommercial risk with Corporate Social Reasonability (CSR) strategies, attempting todemonstrate their cultural sensitivity while winnings the hearts and minds of local communities.Thus far, most efforts have failed to achieve the sought after peaceful relations and stable workenvironment. This paper proposes that CSR efforts, understood as an attempt by firms to ensure asocial license to operate, have failed because the existing conceptualizations of localnoncommercial risk do not recognize that it originates from the interaction of a firm's strategy andthe local community, placing local stakeholders at the center of the risk.

Corporate Social Responsibility: Its Purpose and its Failings.

Although a firms CSR efforts can have different goals: moral obligation, sustainability, sociallicense to operate and reputation, this paper will take the license to operate as the principal goal of

CSR efforts. This means that a firm implements a CSR effort in order to help achieve and orpreserve a social license to operate, generating a stable work environment in which they may carryout their business free from negative interference by local communities. CSR efforts frequently fallshort of this goal as they lack the context-specific knowledge necessary for addressing stakeholderdemands. The cause of these failures is poor understanding on the part of firms of thenoncommercial risks that create inhospitable and unstable operating environments.

Shortcomings in Corporate and Academic Understanding of Noncommercial Risk and the

Resulting limitations of Analysis based on that Understanding

The literature on noncommercial risk possesses many diverse definitions and interpretations of thephenomena, few of which are readily applicable to local noncommercial risk. At the root of theconfusion is the assumption that noncommercial risk is fixed within a given country. Economic ormacro political risk may be fixed within a country but local noncommercial risk is the result of

corporate strategies interacting with stakeholders within the system. A firm acts, the stakeholdersreact, and a noncommercial risk that affects operations arises. Local noncommercial risk is theresult of adverse action by local secondary political and social-cultural stakeholders stemmingfrom their perception of a firm's strategy and its effect on the community.

The failure of firms to recognize this fact severely limits the analytical value of any traditionalnoncommercial risk measurement in the crafting of a strategy to mitigate such risks. Countrystability and/or political risk indexes, which aggregate countrywide political, economic, and socialvariables as a measure of the noncommercial risk in a country, are an example of such fruitlessanalysis. In such indexes stakeholder demands are replaced with aggregate statistics, and firmstrategy is completely absent as a variable. Nevertheless, they are the most commonplace measureof noncommercial risk utilized firms in their analysis.

Moving Noncommercial Risk Assessment from a Focus on Environment to a Focus on

Stakeholders

The weakness common to the aforementioned attempts at understanding noncommercial risk isconfusion regarding its cause; as a result, firms frequently fail at finding an appropriate method formitigating risks. Disjointed CSR programs that seek to positively influence a host communitys

perception of a firm, come up short because a stable operating environment cannot be achieved

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without addressing specific stakeholder needs. In order to address such needs, a firm mustrecognize that they arise from an expectations "gap" between the performance of a firm/theexecution of its strategy and the expectations of what that performance will mean for stakeholders.By identifying key stakeholders, who may pose a risk to a firms strategy, firms can engage moreeffectively and make strategic adjustments, the result being CSR efforts that can close thestakeholder expectations gaps.

A Sequenced Approach to Crafting CSR Strategies to Counter Noncommercial Risk

Addressing all of the aforementioned issues in a static model is difficult, especially given the clearneed for context-specific knowledge. As such, it is necessary to recognize that best practice canonly ever be a general road map, given this constraint, we propose that the following four-step

process be followed:

1) Firms must look inward and articulate clearly their own goals and strategy for a project.2) Firms must collect atmospherics/information on the local communities that their project is goingto affect. Firms must then reassess goals and strategy and align as best as possible with the

apparent social-cultural and political norms of the principal secondary stakeholders as much aspossible.3) A firm should initiate engagement with secondary stakeholders in two ways: first witheducational meetings exploring the nature of a projects industry/nature and secondly with project-specific meetings. The educational meetings allow firms to teach the limitations of a projects

benefits and project-specific meetings all firms to collect community impressions and concerns.4) Finally, firms should review and prioritize the inputs, suggestions, demands, and potentialthreats from secondary stakeholders, all should be prioritized based on impact on value creation ofa project for the firm. Firms will then need to choose which issues to address based on impact onthe ability of a firm to create value for shareholders.

At all times, the affect and success of every effort should be measured, and its progress towards apredetermined goal should be measured. The repetitive nature of this process cannot be overstated,it should be repeated as frequently as possible, with an emphasis on education and radical

transparency, both of which will earn respect and increase the ease of conversion to a firmsposition.

Measures of Effectiveness: The critical step in a successful noncommercial risk mitigation

strategy

The single most important factor in successful engagement and management of noncommercialrisk is attempting to measure the effectiveness of such efforts. The failure to do so is often thecause of the uncoordinated initiatives most companies claim as their CSR efforts. Absent goodmeasures of success and failure, firms cannot properly assess the effectiveness of noncommercialrisk mitigation efforts. As a result, noncommercial risk lacks meaning within the broader contextof a firmsproject strategy. Despite the importance of measurement, it remains one of the mostdifficult tasks in the management of noncommercial risks principally because measures ofeffectiveness must be tailored to the situation and operating environment. Although, broadly

speaking, they can be divided into three categories, social measures, informational measures, andeconomic measures, the specific dependent and independent variables being assed will alwaysdepend on the mix of secondary stakeholders that pose a risk to a firm and the nature of its project.The the number of disputes between foreign investors and host states ison the rise and not sincethe 1980s have we seen as many government interventions in energy and mining investments aswe have in the last two yearsmany as a result of or accompanied by vigorous community




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opposition.1This troubling trend is the result of a failure on the part of firms, specifically foreignmultinationals engaged in the extractive industries (principally mining, and oil and natural gas) totake into account local political and social-cultural stakeholders (who are collectively referred to aslocal secondary stakeholders in this paper) who can create contentious operating environments thatfrequently lead to failed projects or otherwise suboptimal outcomes.In order to address this situation what is needed, as Stephen Korbins highlighted in 1977, isbetter definitions of the [noncommercial risk] phenomena, a conceptual structure relating [to] thefirm and a great deal of information about the impact of the political environment.2In recent years many firms have attempted to avoid the financial penalties of local noncommercialrisk with Corporate Social Reasonability (CSR) strategies, attempting to demonstrate their culturalsensitivity while winnings the hearts and minds of local communities. Thus far most efforts havefailed to buy the stable space and peaceful relations with local communities that firms hoped theywould. This paper proposes CSR efforts, understood as an attempt by firms to ensure a sociallicense to operate, have generally failed because existing understandings and conceptualizations oflocal noncommercial risk originates from within a companys strategy, which is to say that the riskis a result of corporate action rather than a fixed issue that is simply present in the social and

political environment in which a company operates in.

See comments throughout the paper. Some are very minor; others, substantive.Overall, the writing is much improved at the sentence level, but the difficult task remains ofcreating a long document (hopefully, shorter than this draft) that has a coherent argument inside

paragraphs and running from beginning to end of the paper.I am going to ask you to tell me in three or four sentences the argument and points of each chapter.And then suggest you use subtitles to keep you focused on those arguments and points.I think you will end up discarding a lot of material that isnt relevant to what youre trying to argue.Thats difficult for all of us. Once we learn something when we are focusing on a topic, its hardto throw it out of the final product. But, it needs to be done.

I also believe youll end up re-ordering a good deal of the paper. The same points appear anumber of times in different parts of the paper. Consolidate! I think that will happen if you makesubtitles (better, full sentence subtitles that say what the section is arguing). Youll discover thatsentences and paragraphs are often out of place.

See you tomorrow.Lou

Chapter One: Introduction

The best of business opportunities can go awry when local political and socio-cultural stakeholdersare not taken into account, as Meridian Gold learned when it attempted to build a gold mine in themountainous and picturesque town of Esqual in the Chubut province of Argentinean Patagonia.One of the towns main attractions is the Old Patagonian Express that runs through the foothills ofthe Andes, winding its way over pristine mountain rivers and through alpine valleys. Esquel is alsothe gateway to the Los Alerces National Park, famous for the rare Alerce tree, a species unique tothe region and capable of living up to 3,000 years. The town is also happens to be home to a rocky

1Lisa J. Laplante and Suzanne A. Spears, Out of the Conflict Zone: The Case For Community ConsentProcesses In The Extractive Sector, Yale Human Rights & Development Law Journal69 (2008): 70.

2Stephen J. Korbin, Political Risk: A Review and Reconsideration.Journal of International BusinessStudies10, no. 1 (1979): 77.

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outcrop seven kilometers to the east that possesses a rich vein of approximately 3-million ouncesof gold.3It was at this site that Meridian Gold, a Nevada-based gold miner, intended to develop an open-pitgold mine, complete with facilities for extraction, processing (via the cyanide vat leachmethodology), and waste disposal. In 2002, Meridian acquired the site as part of a $310 millionacquisition from Brancote Gold, a London-based mining and exploration firm, and quicklycommenced a staged build- out of the mine, starting with the setting up of a laboratory to test thecyanide process and the quality of the ore. Meridian did all this shortly after publicly dismissingthe town of Esquels recently-completed, and widely accepted, development plan for thecommunity.Meridian moved ahead with mine development despite mounting opposition from the communityof Esquel. In the end, Meridian did try to win the town and community over with a widespread

public relations campaign, but it was too little, too late, and the company was not able to changethe communitysperception of Meridian as an unresponsive foreign firm that is unwilling toengage in meaningful dialogue about community interests and concerns. By February of 2003, thecommunity had turned on Meridian, and the mayor authorized a public referendum on the

proposed mine. The referendum produced disappointing results for Meridian, with 81% of voters

coming out against the project.4

Subsequently, the Chubut province government banned open-pitmining and the use of cyanide in the mining process, bringing Meridian's high hopes for the mineto an end.5The failure to develop the mine resulted in Meridian needing to write down the value ofthe Esquel property to its fair commercial valuewithout mineral resources, resulting in a net lossfor the fiscal year ended 2005 of $346.4 million.6In 2007, Canadian mining firm Yamana purchased Meridian. At the time, Yamana had no plans todevelop the Argentine site, and the firm's CEO, Peter Marrone, stated the local community hastaken the position that they prefer not to have a mine, and so our position is that were respectingthat, and, so we are withdrawing our efforts as they relate to Esquel.7A review of recent Yamanacorporate filings suggests that nothing has changed and so, as a result of one firm's oversightand/or ignorance of local noncommercial risks, 3-million ounces of gold (worth roughly $4

billion at today's prices) remains locked in the mountains surrounding the town of Esquel.8

This is a common story, and highlights the trouble that can result when foreign firms move

forward with large-scale foreign direct investment without local stakeholder buy-in.9

The failure offirms, specifically foreign multinationals engaged in the extractive industries (principally mining,and oil and natural gas) in the case of this paper, to take into account local political and social-cultural stakeholders (who will be collectively referred to as secondary stakeholders in this paper)runs the risk of creating a contentious operating environment that can lead to a failed project or anotherwise suboptimal outcome.

3No Dirty Gold, Esquel Argentina,last modified April 14th, 2006,http://www.nodirtygold.org/esqual_argentian.cfm

4Jonathan Sohn,Development Without Conflict (Washington D.C., World Resources Institute), 28.5Sohn, Development Without Conflict, 28.6Sohn, Development Without Conflict, 28.7Romina Maurino, Yamana Set to Expand to 7 Mines, Develop 5 Projects, The Star, October 18, 2007.

http://www.thestar.com/business/2007/10/18/yamana_set_to_expand_7_mines_develop_5_projects.html8The term noncommercial risk refers to risks to business operations that stem from social-cultural tensions,

environmental factors, security issues, and government/political factors. This thesis uses the term noncommercial riskin place of terms like political risk or country risk as it is a more inclusive term for a category of risks that are fuzzyand difficult to quantify. Furthermore, as Stephen Kobrin pointed out in his workManaging Political Risk Assessment:the common functional divisions of the external environment (e.g., political, social, legal, cultural, economic) areanalytical abstractions that breaks down at the level of experiential reality. (pg. 29)

9Yongqiang Gao, Managing Political Risk in Cross-National Investment: A Stakeholder View, SingaporeManagement Review 31, no. 1 (2009): 104.

Comment [LW1]:Not quite sure wmeans.

Comment [LW2]: Was this net of pelsewhere, or was this the amount ofoff? Not terribly important which, bwritten, its not clear.

Comment [LW3]: What kind of righave to the mine? I assume in Argenalmost every country outside the USbelong to the state. Had the Argentigovernment given the company sommining license? If so, did the governmake some kind of commitment withto acquiring access to the minerals foinvestor? These are common. Woul

company have had a claim based on it had acquired and which were in sotaken?

Comment [WT4]: Check




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In recent years, many firms have attempted to mitigate risks arising from secondary stakeholderaction with Corporate Social Reasonability (CSR) strategies, which seek to win the hearts andminds of local communities. In essence, firms have sought to buy peace. CSR efforts have hadmixed results and have been received by secondary stakeholders as little more than superficialwindow-dressing efforts which demonstrate, with no particular depth, the foreign firmscommitment to sustainable and socially responsible practice, as Lite Nartey demonstrates in her

paperExternal Stakeholder Engagement: Transforming Corporate Social Responsibility fromPrinciple Rhetoric to Theoretically Grounded Practice.10

The concerns of secondary stakeholders are not without merit; ill-conceived execution of large-scale projects in the extractive industries has a track record of damaging local communityenvironments and economies and at times even infringing on basic human rights. Presently, the

poor record of extractive industries of taking into account the concerns of local stakeholders hasmade the easy implementation of projects beneficial to both host communities and corporations allthe more difficult, and has indeed prompted introspection on the part of many firms operatingwithin the extractive industry. Such introspection has resulted in many within the industry tepidlytaking up the mantra of Free, Prior, and Informed Consent (FPIC). Sadly, the operationalization ofFPIC has proven difficult, and it appears to be as much a "window dressing" as related CSR efforts.

Although not initially conceived of as risk mitigation strategies, FPIC and CSR are increasinglylooked to as methods to mitigate noncommercial risk. Thus far FPIC and CSR efforts have provenless than adequate, as the number of disputes between foreign investors and host states ison therise and not since the 1980s have we seen as many government interventions in energy andmining investments as we have in the last two yearsmany as a result of or accompanied byvigorous community opposition.11This is largely the result of a failure on the part of bothacademics and practitioners to answer Stephen Korbins 1977 call for better definitions of the[noncommercial risk] phenomena, a conceptual structure relating [to] the firm and a great deal ofinformation about the impact of the political environment.12The goal of this thesis is to answerKorbin's call and, in doing so, create a framework for operationalizing noncommercial risk thatwill allow critical extractive industry projects to move forward while still respecting the rights ofsecondary stakeholders to respond to legitimate environmental, human rights, and other threats.This paper proposes that many efforts to engage stakeholders by extractive industry firms fail

because definitions of noncommercial risk are inadequate to the task, leading to poor

understanding of the problem, along with misguided information collection and assessment on thepart of corporate leadership. The result is that CSR/FPIC efforts often come up short, and thus failto negate risks, because they lack context- specific knowledge of local issues, fail to involvesecondary stakeholders, and are often not integrated into the strategic plan for a firms investmentand project in a given area. These shortcomings result in a perception gap on the part of the hostcommunity between the promise of project and the actual results. This perception gap is in partthe caused by the focus of noncommercial literature on the idea of the political environment asgiven and exogenous.13Such thinking has resulted in attempts to simply to avoid noncommercialrisk altogether either by transferring risk via risk management products such as political riskinsurance or by discarding otherwise potentially profitable projects. Although political riskinsurance is a useful product for risk management, it is both expensive and limited in its scope, andavoiding projects is clearly not a profitable, or wise, long-term strategy.

10Lite Nartey, External Stakeholder Engagement: Transforming Corporate Social Responsibility fromPrinciple Rhetoric to Theoretically Grounded Practice. (Paper presented at the Annual Strategy and the BusinessEnvironment Conference at the Kellogg School of Management, January 15, 2010): 3.

11Lisa J. Laplante and Suzanne A. Spears, Out of the Conflict Zone: The Case For Community ConsentProcesses In The Extractive Sector, Yale Human Rights & Development Law Journal69 (2008): 70.

12Stephen J. Korbin, Political Risk: A Review and Reconsideration.Journal of International BusinessStudies10, no. 1 (1979): 77.

13Gao, Managing Political Risk in Cross-National Investment: A Stakeholder View,102.

Comment [LW5]:Not essential, buavoid split infinitives.

Comment [LW6]: Does it ever covcommunity relations?? Even if it dodoesnt cover future profits, I suspecOPIC covers investment, not the NPVearnings. Plus there is the equivalen

co-pay not 100% of investment i


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Some authors recognize the endogenous nature of political risk, and as such realize that activeengagement with the political and social-cultural environment in which firms operate is a possibleapproach to addressing noncommercial risks.14This paper continues that line of thought and positsthat it is only through a shared vision of the future, produced through a vigorouseducation/influence strategy on the part of firms, that local communities and extractive industryfirms can live in harmony and thus allow firms to work unhindered . Historically, the extractiveindustries have attempted to manage community-related risks in order to protect their license tooperate, while communities have disrupted projects in order to protect their way of life. This is acontentious arrangement, but it need not always be so; if properly executed, influence strategiesgeared towards achieving an outcome in keeping with the principles of FPIC (albeit not outwardlyendorsing FPIC) should allow for the forward development of projects in less conflictedenvironments.This paper will set out a framework for information collection and assessment that will allow forthe effective design of education/influence strategies to counteract local noncommercial risk byfirst exploring in detail the shortcomings of both current methods for analyzing noncommercialrisk assessment by corporations, which primarily focus on geopolitical and country risk issuesrather than local concerns, along with CSR and FPIC, which set the stage for a contentious

relationship between host communities and the extractive industries by leading corporatestrategists to develop plans informed by misleading or non-relevant information.15This analysiswill culminate in a definition of noncommercial risk that can be used to guideinformation/corporate intelligence collection efforts and analysis. Second, we will turn to severalcases of extractive industry conflict and cooperation in search of best practices for operationalizingeducation/influence strategies based on good information resulting from our newly proposeddefinition. Finally, we will synthesize these best practices to create an information collection andmanagement framework for effectively operationalizing political risk information within thecontext of an influence strategy that we believe can lead to the development of a more collegiallocal operating environment for extractive industry firms.

Chapter Two: Failure of CSR/FPICCorporate Social Responsibility: Its Purpose and its

Failings.

This paper will argue that noncommercial risk generally originates from within a companysstrategy, which is to say that the risk is a result of corporate action rather than a fixed issue that issimply present in the social and political environment that a company operates in. As such it needsto be addressed in a more proactive manner by a firm than is typically practiced. At the currenttime CSR and FPIC are ideas in vogue that, although not directly geared towards risk mitigation,have been adopted by firms as a route toward establishing a stable work environment for projectsand investments, in essence an environment of decreased noncommercial risk For example,Shells Nigerian operations have often made use of the Shell CSR team, the Shell PetroleumDevelopment Company (SPDC), in order to try and avoid the frequent halts in oil operationsresulting from community protests.16

There are several issues with such efforts that have stunted their value. First is that suchpractices are necessarily short-term; in the case of SPDC projects the budget for local developmentprojects is typically closed after construction in a difficult area is completed. As Jedrzeji GeorgeFrynas comments in his paper The False Developmental Promise of Corporate Social

Responsibility, if social projects are initiated in order to buy a short spell of peace, the companies

14See Boddewyn, 1998, Hadjikhani, 200015Jo Jackobsen, Old Problems Remain, New Ones Crop Up: Political Risk In The 21st Century Business

Horizons 53, no. 5 (2010): 482.16Jedrzej Goeroge Frynas and Kamel Mellahi, Political Risk as Firm-Specific (Dis)Advantages: Evidence

on Transnational Oil Firms in Nigeria, Thunderbird International Business Review45 (2003): 584

Comment [WMT-HSIB7]:






Comment [LW8]: Do you mean thnoncommercial risk? It doesnt seplausible for, say, broad nationalizathappened in Venezuela. Surely, theyresult of noncommercial risk, but it ithat they were the result of corporateinaction). Do you not intend to limitanalysisand thus the kind of noncorisk you deal withto community-rerisks?



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are unlikely to engage in proper consultation with the entire affected community. In line withstakeholder theory, firms will listen primarily to those stakeholders who pose the greatest threat totheir operations, not those best placed to contribute towards developmental aims.17 It is thus notsurprising that many CSR efforts do little more than provide communities with shallow

philanthropic gestures (school textbooks, mosquito nets, etc) while failing to consult localcommunities on what exactly their needs are.

AnEconomistarticle that examined Shells efforts in Nigeria highlights these ongoingchallenges:Having looked at 82 of the 408 projects on Shell's booksranging from the electrification ofvillages to building schools and hospitalsthe team concludes that less than a third have beensuccessful. Farm projects and those that aim to make villages more self-sufficient by giving themthe means to earn more do least well. The micro-credit schemes run by women do best. The reportfinds that the company has still been decreeing too many projects from on high. Although it hastried, it is still essentially buying off the locals with giftssome of them forced out of it byransom-demanding kidnappers and protection-merchantsrather than helping people to developtheir future.18

Besides the obvious "short-termism", CSR efforts fail at risk mitigation because they often lackcontext-specific knowledge of the problems a community is faced with and the concerns acommunity has regarding a specific project. Shells SPDC is again a perfect example. Shelloperates throughout the world, from Nigeria to Yemean to the Gulf of Mexico, and the demands ofsecondary stakeholders in such a diverse geographic theater of operation isare immense. In

Nigeria the SPDC needs to be on the lookout for corruption in a way they do not when seeking toaddress community needs in the Gulf of Mexico, but they perhaps do not need to be as careful withoffending local religious customs as they might when operating in Yemen. There is no substitutefor context-specific knowledge, the inclusion of which would immediately go a long way towardsaddressing short-termism.

Another element of CSR failure stems from not involving impacted affected stakeholdersthemselves in the development of CSR efforts. CSR efforts frequently are, as with Shells SPDC,designed at home offices or far from projects. According to Jedrzej Frynas, in villages he visitedin the Niger delta, even in some where the local community had signed a formal memorandum of

understanding with an oil company for delivery of a wide range of development projectsthelocal people sometimes saw a representative of the company less than once a year. When oilcompany representatives do visit local communities, they do not stay overnight and theirconsultation exercise may involve only one or several meetings with key communityrepresentatives.19In short, CSR efforts are built off of limited knowledge and limited consultation.The SPDC again serves as an example of what can go wrong when such an approach is employed.It has been reported that Shell built three town halls as part of SPDC work in the Niger River Delta,not because the communities needed them, or that building them addressed a concern regardingShells investment and projects in the region, but because village chiefs asked for constructioncontracts for their construction firms.20

It should be unsurprising that CSR efforts fail when communities are not consulted.Historically philanthropic efforts work best when they target those who are willing to helpthemselves and thus avoid developing a dependency mentality. As E.F Schumacher has suggested,

17Jedrzej Goeroge Frynas, The False Developmental Promise of Corporate Social Responsibility,International Affairs81, no. 3 (2005): 585

18Nigeria and Shell: Helping But Not Developing, The Economist, May 10, 2001,http://www.economist.com/node/617266.

19Frynas and Mellahi, Political Risk as Firm-Specific (Dis)Advantages: Evidence on Transnational OilFirms in Nigeria, 590.

20Nigeria and Shell: Helping But Not Developing, The Economist, May 10, 2001,http://www.economist.com/node/617266.

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Comment [LW9]: Is it realistic to efirm to circumvent a chief in a local determine what the community wantthe chief the one who is going to stir(or suppress trouble) and therefore thplease? I suppose it depends on the

structure, but I can imagine in some pleasing the chief is the point.


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"if rural people of the developing countries are helped to help themselves, I have no doubt that agenuine development will ensure[but it] cannot be produced by skillful grafting operationscarried out by foreign technicians or an indigenous elite that has lost contact with the ordinary

people."21This is not to say that CSR is pointless; this paper will in fact make the case that attempting

to be a social responsible stakeholder will mitigate noncommercial risk, as it should allow firms tocreate stable work environments. That being said, the efforts need to be properly executed. Withall things, as the saying goes, "the devil is in the details". Superficial window-dressing effortswhich demonstrate, with no particular depth, a foreign firms commitmentto sustainable andsocially responsiblepracticewill not succeed at mitigating the risks created by secondarystakeholders who feel misused by foreign firms investing in local communities. Meanwhile, anysincere attempts to move beyond window-dressing efforts often fail because definitions ofnoncommercial risk are inadequate to the task of diagnosing the problem, leading to poorunderstanding and misguided information collection and assessment on the part of corporateleadership.

Although a firms CSR efforts can have different goals: moral obligation, sustainability, social

license to operate and reputation, this paper will take the license to operate as the principal goal ofCSR efforts. This means that a firm implements a CSR effort in order to help achieve and orpreserve a social license to operate generating a stable work environment in which t carry othertheir business free from the negative interference by local communities. CSR efforts frequently fallshort of this goal as they often lack the necessary context-specific knowledge and fail to involveaffected stakeholders in development of CSR initiatives. The root cause of these failures is poorunderstanding on the part of firms of the noncommercial risks that create inhospitable and unstableoperating environments.

Shortcomings in Corporate and Academic Understanding of Noncommercial Risk and the

Resulting limitations of Analysis based on that Understanding

The literature on political and country risk posses many diverse definitions and interpretations ofnoncommercial risk, few, if any, are not flawed and or inapplicable to local noncommercial risk.

The diversity of literature and possible understandings of noncommercial risk, and the often-inappropriate application macro focused definitions to local issues, makes the analysis andintegration of local noncommercial risks into a firms strategic planning difficult. This difficulty inturn makes the pursuit of a stable local operating environment challenging, and the result of CSRefforts pointless as they often target a misdiagnosed problem.The principal shortcoming of existing understandings of noncommercial risk, that makes theminapplicable to local noncommercial risk, is the assumption that noncommercial risk is fixedwithin a given country. Although there are risks are already present with in different countries,local noncommercial risks are not. Local noncommercial risk is the result of corporate strategiesengaging with the system. The firm acts, the community reacts, and a noncommercial risk thataffects operations arises. In order for firms to better mitigate local noncommercial risk, andinvigorate CSR efforts, they must recognize local noncommercial risk as the impact of adverseaction by local secondary political and social-cultural stakeholders stemming from a firm's strategy.

The failure of firms to recognize this fact severely limits their subsequent analysis of

noncommercial risk to the measurement of country stability and macroeconomic variables. Suchanalysis typically takes the form of a country risk ranking which attempt, utilizing political,economic, and social variables measure the noncommercial risk in a country in comparison toother countries. The necessarily macroscopic perspective of such rankings, and the inability to

21E.F. Schumacher, Small is Beautiful: Economics As If People Mattered(New York: Harper & Row, 1973):216.

Comment [LW10]: If this is a quotyou need a citation. (You dont for devil.


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integrate a firms strategy as a variable in such rankings, makes them particularly poor tools for theanalysis of local noncommercial risk. Nevertheless, they are the only commonplace measure ofnoncommercial risk available to firms in their analysis.

Chapter Three: Defining Noncommercial Risk

The literature on political and country risk is confusing, partly because different authors havedifferent definitions and use different terms, and the work is and includes an ever-changing set ofterms that is often used in a less- than-no rigorous. As a result, fashion, making the academicinformation analysis obtained from such of noncommercial risk analysis especiallyis difficult forcorporate leadership to process and understand. This is a significant flaw that leads to useless Theinformation and analysis, that in turn is difficult to operationalize and fails to achieve the buy-in ofsecondary stakeholders. In addition, the wide and varied understandings of noncommercial riskhave prevented the emergence of consensus and on [?] best practice, making it difficult for firms toimproveperformance.All fFirms and businesses are of course different, including being and subject to different varyingrisks, but that does not mean that the assessment of social-cultural and political environments

should proceed without some common threads. Once again, what we are searching for in this paperis to answer Stephen Korbins 1977 call for better definitions of the [noncommercial risk]phenomena, a conceptual structure relating [to] the firm and a great deal of information about theimpact of the political environment.22 There are better definitions, that can yield best practicesand improve a firms performance by mitigating noncommercial risks, and it is just a matter ofdiscovering what they are. Given the similar issues faced by firms in the extractive industries, aclass of business particularly susceptible to noncommercial risk, this paper will focus on the issuesconfronted by business in mining, and oil and natural gas and in doing so develop a more rigorousframework for assessment and risk mitigation. That process starts with a workable definition ofthe problem.What is referred to in this paper as noncommercial risk has a wide and varying terminologyassociated with it; a varied terminology that is accompanied by an equal variety of evaluativeapproaches that do not relate or build on each other in any noticeable way. Table 1, adapted fromBouchet, Clark, and Groslambert, depicts this diversity, presenting the different terms used to

describe noncommercial risks, the multiple definitions of some of those terms, as well as numerouspossible sources, impacts, historical perspectives and methodologies. Each bullet point representsdifferent ideas related to thinking on noncommercial risks:23

As one can see, this information makes it difficult for a corporate strategist unfamiliar with thesubject (in the case of most firms the Chief Risk Officer (CRO) who is likely best versed infinancial risks), to chart an information collection strategy and subsequent risk mitigation strategy.

22Stephen J. KorbinKobrin, Political Risk: A Review and Reconsideration,77.

23Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment. (New York:John Wiley & Sons, 2003):10

Table 1: Various approaches of the literature on country risk

Terminologies Definitions of Risk Sources of RiskNature of

Investment

Historical

PerspectiveMethodology

Political RiskPerformance

variance

Sovereign

interference

Foreign Direct

Investment1960s-1970s Qualitative

Country Risk Negative outcomeEnvironmental

Instability

Banking

Commercial Loans1980s Quantitative

Sovereign RiskPorfolio

Investment1990s-?

Cross-border Risk



Comment [LW11]: I wonder why section doesnt come before the prevon CSR. Might one not first define tproblem before pointing to the failurapproach to solving it?

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Formatted: Indent: First line: 0"

Comment [LW12]: Are?

Comment [LW13]: Is this what yo

Comment [LW14]: Sorry. I dontwhats being said here. Do the seconstakeholders read the academic litera

doubt it!Comment [LW15]: This whole parneeds to be sharpened.

Comment [LW16]: Seems out of pearly in the paper?

Comment [LW17]: Are wide andifferent? Id have possibly understovarying to mean changing over timthe intent?

Comment [WT18]: Fix

Formatted:Font:

Comment [LW19]: Clean up capitin table. Why is country risk not relFDI? Table isnt at all clear. What historical perspective mean? Literthat period? Risks that materialized that period? Is there a difference betpolitical risk and country risk and sorisk? Not sure what cross-border rissuppose this confusion is what yourpoint out, but it still isnt clear what tcomes from or the data in the cells m

Comment [LW20]: Do most mininhave such? I really dont know norhetorical question.

Comment [LW21]:Not in the tabl


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Do they examine country risk with an eye towards its negative effects on the firm, in light ofpotential sovereign interface? Do they look at the wave of nationalizations in the 1960s and 1970sin search of methods for avoiding a similar event? Do they take a purely quantitative approach andassess the risks as abank might, in a purely quantitative way? Although the right approachcertainly differs by industry and firm, there are no clear guidelines as to which approach a

particular company n industry should use, or even a simple starting point. A firms CRO is thusleft to wonder to and fro in search of answers.The remainder of this chapter will sort through some of this variety of terms, ideas, and approachesto the assessment of noncommercial risk in order to highlight the lack of consistency the thinkingon noncommercial risk produces, which in turn makes operationalization of such noncommercialrisk information for the development of risk mitigation strategies particularly difficult and complex.Perhaps the most important trend to notice in the definitions and thinking explored in this chapteris that all assume noncommercial risk is fixed within a given country; as this chapter will begin todemonstrate, we believe this is a central flaw of the field, and that in order to createnoncommercial risk mitigation strategies noncommercial risk must be seen in a fundamentallydifferent light.

History of Noncommercial Risk

Since the 1960s, the a rapidly growing proportion of firms profits has generated its generated byprofits overseas activities has been growing rapidly. through international operations. According tothe latest available aggregate data (2006), the number of multinational corporations (MNCs) in theglobal economy has increased to 78,000, with total sales of $25 trillion and employment of 73million people.24The extent of overseas activity measured in terms of Foreign Direct Investment(FDI) reflects a similar trend, with the total cumulative value of FDI standing at $112 billion in1967, growing to $4.1 trillion in 1998 and expanding to $7.1 trillion in 2003.25Emblematic of the growing importance of overseas commerce to Global Gross Domestic product(GDP) is the rise in economic power enjoyed by MNCs. As the primary agents of globalization,MNCs have witnessed year-on-year increases in the volume of economic activity they generate,from less than 5% of global GDP in 1970 to 10% in 2003. However, such figures underestimatethe growth of MNCs, since much of their growth is financed internally or from capital markets . . .

they now account for up to a third of world output and two-thirds of world trade, with around aquarter of world trade being between branches of the same company.26Not surprisingly, therevenues generated by some MNCs are significantly greater than the GDP of many nation states.Specifically, the combined revenues of the ten largest MNCs in 2003 exceeded the combined GDPof the worlds poorest 100states. The annual revenue of Wal-Mart ($258.681 billion), one of thelargest MNCs, is greater than the economy of Belgium ($245.3 billion), Saudi Arabia ($188.4

billion), Ireland ($121.4 billion), and Singapore ($86.9 billion), as well as the gross nationalproduct (GNP) of 168 other states.27 Globalization provides greater opportunities, along withgreater risk as complications increase and the spread of operations expands to less-establishedlocations.This is nothing new, though; risks from social-cultural and political issues in disparategeographical locales have long been a feature of international trade and investing. Evidence ofextortion and expropriation of assets of foreign investors can be found as far back as ancient

24Todor Petkovic and Marko Rakic. Transnational Companies: A Global Empire. Megatrend Review7.2(2010): 292.

25United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2003 (NewYork and Geneva: United Nations, 2003).

26Jonathan Perraton, David Goldblatt, David Held and Anthony McGrew, Economic Activity in aGlobalizing World, in David Held and Anthony McGrew (eds.), The Global Transformations Reader (Cambridge:Polity, 2000), p. 296.

27Petkovic and Rakic. Transnational Companies: A Global Empire. 292.

Comment [LW22]: Do banks act tway???

Comment [LW23]: wander?


Comment [LW24]: This may be thyour thesis. If so, Id probably put itat the beginning. It would go along

fact youre dealing only with extractiindustries and with one kind of noncrisk: that arising from problems withcommunity. If you do that, it will bewhat the thesis is about, and the analfollow more clearly.


Comment [LW25]: Does the rewriprevious sentence convey what yousay?

Comment [LW26]: These data donthe point made in the previous senten

Comment [LW27]: The previous sdoes not have data that show a trend

Comment [LW28]:Now, this showBut it doesnt support the paragraphsentence, which is about profits.

Comment [LW29]: Commerce inctrade. Youre talking about FDI, I th

Comment [LW30]: Common statedoes it really reflect power?

Comment [LW31]: Is this the pointrying to make in these paragraphs? it up-front, and support it.


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Greece. In the 17th and 18th centuries, high seas pirates posed an ongoing risk for British, Spanish,and French mariners importing exotic wares from the New World, while in the 20th centuryinvasion and armed aggression have beenwere frequent occurrences threatening commercial andcolonial holdings in Europe, Africa, Asia, and Latin America.Political and country risks are thus concepts with a long history in International Relations (IR). Yet,for all of the prevalence of noncommercial risk in the international system, it has received scantattention in the academic discipline of IR. In part, this is explained by the predominance of high

politics in the 20th century. Recurrent inter-state warfare combined with the prospects of nuclearconfrontation monopolized intellectual inquiry and theoretical efforts during the Cold War. Theimpact of politics on business, in contrast, has received little attention. Furthermore, since thePeace of Westphalia in 1648, the sovereign state has been the primary unit of international study.MNCs, given their non-state actor status, have only been topics of study as significant actors onthe international stage, especially in academic study, when they appeared especially susceptible tothe whims of state actors, as in the late 1960s and early 1970s.MNCs are often overshadowed even when it comes to non-state actor studies, such as those ofterrorist organizations, which are perceived as posing an existential threat and thus given primacyin terms of study. Additionally, MNCs have most often been written off as instruments of powerful

states. Many CEOs of MNCs would disagree with this simplistic view; MNCs, at this point, aremore likely to think of themselves as stateless actors, as the following excerpt fromPrivateEmpires: Exxon Mobile and American Powerdemonstrates:

ExxonMobils interests were global, not national. Once, at an industry meeting in Washington, anexecutive present asked Raymond (Lee Raymond, former CEO) whetherExxon might build more refineries inside the United States, to help protect the country against

potential gasoline shortages.

Why would I want to do that? Raymond asked, as the executive recalled.Because the United States needs itfor security, the executive replied.Im not a U.S. company and I dont make decisions based on whats good for the U.S.,Raymond said.28

In short, despite evidence to the contrary, much of the literature in IR has thus been ill-disposed toview MNCs as anything other than either marginal or exploitive, predatory agents subordinate tostate actors, or at the very least as institutions that become subordinate.The reality, in which MNCs are in fact independent actors, makes noncommercial risk analysisthat much more difficult, as the study of most firms would straddle numerous disciplines, a realitythat is the likely source of the terminology difficulties and abstract analytical categories. While notthe primary focus of either economic or political scientists, all MNCs have grappled with the

problem of political and country risk. The ubiquity of political and country risk explains theempirical presence of it, despite its conceptual absence in academic study. [Kobrin?]Country risk and political risk are thus normally understood as a function of IR and as a productthat blooms out of cross-border activities. Indeed, political risk is intimately connected to the statesystem and its organizing principle of sovereignty. Sovereignty has been the guiding principle ofthe Westphalian system, limiting the judicial scope of regulatory orders, property, and individualrights, and exposing individuals, commercial actors, and state agents to the uncertainties that arise

from foreign social, political, and economic orders.Ironically, while globalization has witnessed the emergence of transnational regimes (NATO, theUN, the WTO) and the increasing standardization of international norms and rule-governed

behavior, the depth of these regimes has not been so great as to reverse the nature of sovereigntyand the monopoly of force, and coercion possessed by the state within its purview. Even where

28Steve Coll.Private Empire: Exxon Mobil and American Power. (New York: Penguin Press, 2012), 71.

Comment [LW32]: Or is this the pthere are two points (likely), they getMake them individually and organizpresentation to support them. And mclear why they are relevant to your s

Formatted:Indent: Left: 0", Righ


Comment [WT33]: Run on Actuala run-on sentence. It may try to crammuch into a single sentence, howeve


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These clashes have arisen for multiple reasons, but of particular interest here is the decision by thefirm to prohibit prospecting by local residents in the firm's tailings due to health concerns. Thetailings from copper and gold mining can often be quite toxic, but also have some precious metalcontent. The local communities viewed this restriction not as an effort on the part of the company

to safeguard the health of localresidents, but instead as an effort tokeep the local community from

profiting. As a result, the localpopulation protested, shutting themine down for four days at a cost tothe company of $12 million a day.34This example demonstrates thefeedback loop shown in Figure 1:

Figure 1: Noncommercial RiskFeedback Loop35The firm acts, the community reacts,

and a noncommercial risk thataffectsimpacts operations arises.Additionally, the Brink definitionfalls short in that it results in a

tendency to conflate sovereign debt risk, often referred to as country risk, with political risk. AsLlewellyn D. Howell, author of The Handbook of Country and Political Risk Analysis, suggests,this conflation is all too common and ignores social, cultural, and purely political dynamics at playin most markets.36On the other end of the definitional spectrum, noncommercial risk is defined not in terms ofdiscrete events but rather in terms of country stability or volatility. This has become common inthe political risk consulting world, as stability is an idea political scientists have spent a great dealof time trying to measure and model. However, this definition misinterprets volatility; althoughvolatility is often considered a negative risk, especially in the financial world, this is not always thecase.

Some, such as Brink, believe that: the underlying risk that political instability holds for theforeign organization is the possibility that political disequilibrium might result in governmentlimitations on producing profits.37Although this is certainly a major possibility, it is also possiblethat political volatility would create opportunity for further investment, or great profits. Forexample, a post-Peronist regime in Argentina came to power via a military coup, yet had a more

positive view of foreign investment than the presidency of Juan Domingo Peron. It turned out thatimpending political instability presaged a better investment environment. Another example is the

benefits enjoyed by the armored car industry in 2001 that resulted from the "war on terror" andgrowing instability throughout the Middle East following the events of September 11th, 2001, bothof which led to a dramatic increase in sales.38The narrow viewpoint of stability and volatility as an undesirable risk is a particularly important

issue for corporate leadership,

34Tamara Bekefi and Marc J. Epstein,Integrating Social and Political Risk Into Management Decision-Making, 12.

35Based on Appendix 1 Exhibit: Tamara Bekefi and Marc J. Epstein,Integrating Social and Political RiskInto Management Decision-Making, 12.

36Llewellyn D. Howell. The Handbook of Country and Political Risk Analysis.(New York: Political RiskServices, 1994): ___

37Charlotte Brink,Measuring Political Risk: Risks to Foreign Investment. (Burlington VT: Ashgate, 2004).19.

38Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 10

Freeport-

McMoRanCommunity

Decision to

Restrict

Prospecting

Effected

Stakeholders

Perception of

Decision by

stakeholders

Protests

Decision to

Act

Noncommercial

Risk to Firm

0

20

40

60

80

100

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Chart 1: PRS Group IRGC Index Rankings for Libya

Libya Linear (Libya)

Comment [LW40]: Were these truPapuans, or immigrants from other pIndonesia? (I dont know the answe

implications for management must, hdiffer if theyre immigrants, instead oPapuans.

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Comment [WT41]: Define sovereirisk

Comment [LW42]:Not sure I get am I sure its important. True, holdesovereign debt dont have to worry ma local community. But is that someis implied in the definition?

Comment [LW43]: From the prosp

risk associated with the local commuthe point that the local risk can arise country is stable? Why get off on voisnt what youre interested in.

Comment [WT44]: Expand

Comment [LW45]: This is kind ofrelevant to your paper??


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especially in the extractive industries, which would be wise avoid conflating the two; stability isreadily observable and thus can result in a cognitive bias in which political stability (or the absenceof volatility) is associated with the longevity of a particular political regime, and thus seen as aseemingly safe investment environment. Such a misinterpretation could, and certainly has, easilyled to investments that a proper noncommercial risk assessment may have deemed safe but was infact not. As Nassim Taleb highlights, apparent stability is often false, as it involves unobservedrisks being pushed into the statistical tails of the probability distribution.39This tendency createsmacro risk "time bombs." For example, as depicted in Chart 1 (time is laid out on the X axis andpolitical risk is on the Y axis, with 100 corresponding with a hypothetical country lacking

political risk and 0 indicating a country on the throes of upheaval), according to the PRS IRGCindex the situation in Libya improved with each passing year that Gadhafi was in power. Inhindsight, that stability just masked increasing tensions that were brewing below the surface, andsuddenly exploded in late 2010 early 2011.40Just as instability is not innately negative, the study of noncommercial risk has been shortchanged

partly due to a perception that it is only a risk of loss. As Robock highlights, as in the case ofother types of risk, political risk can result in gains as well as losses.41A negative connotation notonly handicaps the ability of noncommercial risk analysis to correctly assess investment

environments but it also handicaps corporate leadership, and as noncommercial risk assessment isonly as useful as its ability to assist corporate leadership in creating value, this is thereforeunsatisfactory. Noncommercial risk necessarily deals with future uncertainties, and althoughuncertainties may do damage, if addressed accordingly noncommercial risk may also present greatopportunity in the form of a competitive advantage. This is the case with oil and natural gas giantChevron, which has developed a framework for collecting, understanding, and utilizingnoncommercial risk information about local political actors to better engage and influence the localcommunities in which it operates. Chevron in fact believes its methods are of such value and soeffective that when recently asked to cooperate in the development of a best practice teachingstudy led by Wharton Business School Professor Witold Henisz it claimed that this process was asource of competitive advantage that they preferred not to have publicized.42 It is just such a

process that this paper aims to produce.The focus on the negative nature of noncommercial risk has resulted in its being separated from

profit making. A business plan or investment is conceived, is evaluated for possible risks to the

plan, and, if it passes the "test,", is implanted. The staged nature of such "planning" often meansthat a company first determines what it would like to do and only then considers whether it shouldnot do it; behavioral economics suggests that the bar for do notwill already have been lowered

by the decision to do.This decision-making structure revolves around the notion that a dollarearned is sweeter than a dollar saved, though of course in absolute terms the two are of equal value.In addition, this approach does not lead to a focus on the risks that result from the plan, but rather afocus on the risks to the plan. Investing is an action and reaction process; it is circular, andnoncommercial risk is as much community feedback, i.e. how a group feels about the business

plan, as it is something already present in the system. As such, noncommercial risk should beincorporated into the decision-making process earlier, along with other forms of risk analysis, as itis a method of maximizing money and planning for the results of implementation.

39Nassim Nicholas Taleb and Mark Blyth, The Black Swan of Cairo: How Suppressing Volatility Makes theWorld Less Predictable and More Dangerous,Foreign Affairs90 no.3 (2011),www.fooledbyrandomness.com/ForeignAffairs.pdf: 33.

40The IRGC index is a measure of overall political risk in a country. The index was developed by consultingfor Political Risk Services (PRS) and includes political, social, economic and financial variables.

41Stefan H. Robock, Political Risk: Identification and Assessment, Columbia Journal of World Business,Vol. 6 Issue 4 (1971): 7.

42Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Managementin Global Projects, in Global Projects: Institutional and Political, 374.

Comment [LW46]: Isnt instabilitynoncommercial risk?

Formatted:Highlight

Comment [WT47]: Crisper

Comment [LW48]: Can you rewritparagraph so that it is more straightfothe point that the ability to manage crisk well can give a firm a competitiv

advantage over its rivals? If so, whyover definitions. Just make the pointillustrate it.

Comment [LW49]: I dont know wparagraph is associated with definitio


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Although the definition of noncommercial risk presented earlier is the most common, there arenumerous others. Perhaps the earliest understanding of pure political risk is that of the CatalogueSchool, which during the 1970s sought to catalogue types of political risks. Still an important"school of thought" that plays a role in almost all noncommercial risk literature, the CatalogueSchool is decidedly limited in its value and is conceptually flawed.43At issue is the School'ssimplistic understanding of noncommercial risk as a set of specific isolated actions. The definitionof noncommercial risk presented by Weston and Sorge is representative of such thinking:Political risks arise from the actions of national government which interfere with or prevent

business transactions.44This definition is rooted in the misconception of political risk as nothing more than governmentintrusion in the marketplace, a notion that has its own philosophical roots in a simplistic laissezfaire understanding of the economy as best left alone and self-regulating. Such a position assumesthat markets are independent entities that are forced to interact with non-market actors and non-market signals, thus constructing a bifurcated image of the relationship between political systemsand economic markets.45Although the deregulation of the 1990s attempted to create such a

bifurcation, economies always exist within the context of political systems. As Jarvis and Griffithshighlight, this artificially disembeds markets and business relations from their socio-political

contexts and sees all political activity as negative, market distorting, and detrimental to businessprofitability.46A second understanding of political risk, the Structural-Functional School, rests on the assumptionthat certain states are more prone to political risk than others, due to political structure andorganization. With this view of political risk comes the idea that a topology of nation states andassociated risks can be created. Such a topology could then be used to form predictive models offuture risks based on correlations between states in reality and the state as it exists in academicliterature. At issue is what Nassim Taleb, author of The Black Swan, refers to as platonicity, or thetendency to confuse the map for the territory.47The hope of Structural-Functional analysis was for the discovery of relationships between thediscrete stages of economic and political development and the risks that firms might be subject towhen investing in such situations. According to Jarvis and Griffiths, while not a predictive toolthat could be correlated to specific future risk events, structural-function analysis could provideinsights into the risk associated with specific stages in the political modernization cycle.48

Besides confusing theory with reality, the Structural-Functional approach to noncommercial riskalso presumes a specific developmental trajectory for the nation state. The result is the implicitclaim that development equals stability and thus lower noncommercial risk, and that undevelopedequals unstable and thus high noncommercial risk. This is the two-fold error of confusinginstability with risk, as discussed earlier, and the assumption that liberal democracy is the finaldevelopmental stage of the nation state. Neither assumption is certain or even clearly supported byobservation.A third and final interpretation of political risk worth mentioning is the Methodological School.Arising during the 1980s, the Methodological School rejected the grand theorizing of theStructural-Functionalist School, and instead sought to develop an explanatory schema with

predictive capacity, plus methods to evaluate the risk environment in relation to industry- and

43Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11.44Fred V. Weston and Bart W. Sorge, International Managerial Finance (New York: Richard Irwin, 1972), p.

60.45Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11.46Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11.47Confusing theory for reality, an all too common occurrence in all social sciences especially with built in

abstractions such as political risk, a term that is itself an abstraction as separating out economics and social-culturalissues from political issues is impossible.

48Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 14.

Comment [LW50]: Presumably, a name? Id put in quotation marks, in

Comment [LW51]: Sounds accurapoint that it is wrong, doesnt includpolitical risks, or that it doesnt covenoncommercial risks?

Comment [LW52]: Id stay away fcontroversy. It doesnt add anything paper. One could say that changes ingovernment intervention pose risks twhether or not they are beneficial to economy.

Comment [LW53]: Arent you onYou need to separate the definitions points, such as the one about a firmsable to turn to an advantage its abilitmanage certain kinds of risks. I thouwas a good point, but completely out

Comment [LW54]: Your term?

Comment [LW55]: This isnt a deit, but rather an analysis? Or, an assuthat is aimed at causality, not definiti

Comment [LW56]:Not definition

Comment [LW57]: But you seem confusing definition with both, no?

Comment [LW58]: This all belongsomewhere else in the paper if at aabout what others think cause certainrisks, or how those risks can be predinot definitional, I believe.

Comment [LW59]: Your term?

Comment [LW60]:NOT definitio


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project-specific applications.49While numerous approaches have been developed, all with varyingdegrees of utility, none has become widely accepted. Most Methodological approaches are relianton qualitative techniques and as such depend upon the ability and expertise of analysts.At issue for political and country risk is the fact thatN none of these approaches is complete, orcompletely without merit. Each suffers from specific shortcomings. Clearly, the Catalogue Schoolhas identified some specific threats, such as expropriation, but other concerns such as labor andsocial unrest do not fall as neatly into discreet categories and can take on many forms andfunctions in society. The initial probabilistic definition presented assumes far too much ability totranslate soft social variables into hard quantitative facts. Another shortcoming of the abovedefinitions appears to be the focus on macro- and/or country-level concerns. This is clearly ondisplay when one transitions from defining political risk to operationalizing political risk.

Noncommerical Risk is in the Relationships, not the Location

As should be clear from the above discussion, defining noncommercial risk and collectingthe relevant information for assessment is a challenge. The different schools that I havedescribed suggest different approaches by firms to noncommercial risk. According to the

Catalogue School, for example, Should corporate leadership should perhaps create a list ofpossible threats. (as the Catalogue School might suggest)? [et cetera] Should they focus onvolatility in the potential market? Or perhaps they should attempt to modal out possible scenarios?Depending on how you define noncommercial risk, you come up with a different answer, and thismakes for an especially difficult corporate planning session, made even more so if multiple outsideconsultants operating from different perspectives are employed or if information is collectedmostly from managers on the ground who are unfamiliar with any formal theoretical structure ofnoncommercial risk.50

As previously mentioned, a common thread running through all the above definitions isthat they overlook the fact that noncommercial risk is often a result of corporate action, not simplyan ever-present risk in a political and social-cultural environment, as Henisz puts it in his essayNetwork-Based strategies and Competencies:

The likelihood that a political or social actor will seek to alter the revenue stream of a corporation

in a manner inimical to shareholders is typically neither a country- nor industry specific risk.Rather, the largest determinant of the risk of an adverse event is often the strategy of the investors.How do they enter? With whom do they ally? Who do they hire and from whom do they sourcematerials and credit? One what terms? Where do they sell? What do they do with their returns?What are their future investment or expansion plans? What sort of public relations, corporate socialresponsibility, and government affairs strategy do they pursue?51

This is just what happened to Freeport MacMoRan as a result of its decision to protect the healthof locals, a strategy that resulted in a loss of at least $48 million. In short, the strategic decisionsmade by most firms in regards to foreign operations may result in the creation of noncommercialrisks as a result of the perception by local communities of the strategic decision. In most cases,how a secondary stakeholder reacts to an issue can transform a strategic decision on the part of afirm into a noncommercial risk. This understanding of noncommercial risk, as a company-generated risk that creates a feedback loop, highlights the key missing element of the previous

49See: David Hertz and Howard Thomas. Practical Risk Analysis: An Approach through Case Histories.50According to PwC 70% of the worlds largest multinational corporations relay on local managers for the

vast majority of their information on noncommercial risks to potential projects.51Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management

in Global Projects, in Global Projects: Institutional and Political, 357

Comment [LW61]:Nothing is at no?

Comment [LW62]: They are muchthan definitions.




Comment [LW63]: Thats not the

sentence for this paragraph. The partries to draw the policy implications various schools youve described definitions, to be sure.

Comment [WT64]: Clearer

Comment [LW65]: Model?

Comment [LW66]:Not

Comment [LW67]: Hardly inherendefinitions, when thats what is beindiscussed. Youve made this point eaWhy not consolidate the varioussections/paragraphs on it?

This chapter needs some serious effoorganization. Make an outline now oyoure trying to say in it. (And dropdebates that arent necessary to your

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definitions: recognition that a companys strategies impact affect the people of the country andlocal communities in which a firm operates, rather than only the other way around.52Once this overlooked factor is taken into account, it is clear that the most often-overlooked actor

in noncommercial risk is the firm itself, and the most often overlooked analysis is that of the firmand its relationship with secondary stakeholders. In absence of secondary stakeholder assessment,a noncommercial risk assessment cannot be considered complete. Additionally, if noncommercialrisks do indeed arise as a result of corporate action, as Henisz believes, an analysis of thosesecondary stakeholder risks is essential for any successful risk mitigation strategy, and acorporation gaining influence over them is thus a key step in achieving success.Going forward, this paper will focus on operate under the assumption that a particular kind of

noncommercial risk is that is best defined as follows: the risk posed by the reactions of secondarypolitical and social-cultural stakeholders to a firm's investment strategy/business plan regarding aspecific project.

Chapter Four: Shortcomings of the Political and Country Risk Index

We now have a working definition of the noncommercial risk that is the subjectdof this paper. This

definition recognizes both the roleplayed by a firms strategy in creating risks and the centralinfluence of individual stakeholders in the process. The next step in operationalizing this definitionis building an understanding of how the risks and a firm's strategy interact, forming a morecomplete picture of who secondary stakeholders are, and then finally following this all up inchapter four with a framework for operationalizing both the definition and the model, yielding fordeveloping an education/influencea strategy for a firm to help mitigate its noncommercial risk.Just as the definitions presented previously failed to provide an adequate guide for the kind ofinformation corporations should seek to collect for a noncommercial risk assessment, so too didthey fail to lay the groundwork for that informations assessment.Our The definition we are now operating under does just that by making the central focus of ouranalysis is on the network of secondary stakeholders within a firm's operating environment. as wellthe firm's strategy, thus linking political and social issues with the strategy a firm employs tocreate value. This is an essential leap and allows for a direct assessment of the potential impact ofdelays, disruptions, or adverse actions by secondary stakeholders on a firm's investments and

operations. Conversely, the failed definitions of noncommercial risk presented in the last chapterhave generally not resulted in a reevaluation of firm strategy, but rather in the most common ofnoncommercial risk assessment methodologies, the country risk ranking, which is difficult orimpossible to link to a firm's bottom line, or even to an individual project. As this chapter willshow, the country risk ranking is not only an inadequate lens through which apply noncommercialrisk, as it does not assess sources of corporate risk, but is also not helpful in crafting anoncommercial risk mitigation strategy. It is only through the integration of stakeholder theoryinto the discussion of noncommercial risk that these shortcomings can be addressed.

The Political and Country Risk Index

As Llewellyn Howell highlights in his Handbook of Country and Political Risk Analysis, politicalrisk and country risk indices and textual analyses have been common in both popular businessmagazines like Fortune and The Economist and in professional business journals like theJournal

of InternationalBusiness Studiesfor more than 40 years.53According to Bouchet, Clark, andGroslamert, this is the result of the fact that it is much easier to estimate a relative level of riskthan an absolute level of risk, once a rating has been established, it is more than straightforward for

52Tamara Bekefi and Marc J. Epstein,Integrating Social and Political Risk Into Management Decision-Making, 45.

53Llewellyn D. Howell. The Handbook of Country and Political Risk Analysis: ___


Comment [LW68]: Can you do besecondary? I rewrote this becauseother kinds of noncommercial risk thnot addressing. Thats fine. You cathem all. But its not very useful to term as if it includes only what youraddressing. As said above, this chap

major rewrite.

Comment [WT69]:


Formatted:No Spacing, Left


Comment [LW70]:Not really a stoperationalizing the definition.

Comment [LW71]: OK

Comment [LW72]: This is chapterthe end of his chapter?

Comment [LW73]: Point made

Comment [LW74]: I really dont uthis paragraph. Can you break it up each point it makes (whatever they aseparate and clear?



Comment [LW75]: Does author reitalicize JIBS and not Fortune and ThEconomist?


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the international manager to determine an appropriate required rate of return by comparing withsimilar existing investments in other countries.54Despite the fact that many advancements inidentifying political, economic, and social variables have been made, these indices still fail to

present a clear path forward for the management of political and country risks, as is demonstratedby the number of firms that operate successfully in unstable or politically risky countries that ranklow on various lists published on a yearly bases. Some prime examples are Exxon Mobil, whichhas for years operated successfully in places such as Equatorial Guinea and Chad, or any of themany oil and natural gas firms currently operating inNigeria.

At its most basic level, the county risk ranking is very simple; in practice, though, it thesimplicity provides cover for numerous subjective decisions. Utilizing a ranking in corporatestrategy is based on the underlying assumption that careful data collection and analysis cangenerate rules for anticipating politico-economic events in a robust way that does not depend on

problematic theory.55This ignores the fact that one of the primary causes of noncommercial riskis corporate strategy, so a purely outward-looking analysis is unlikely compensate for an ill-conceived strategy. The assertion is also faulty, as the use of data requires the careful selection ofwhich data to use, implying some underlying theory regarding which variables matter. Is GDP perCapita important? What about measures of free speech, or perceptions of societal corruption like

those used by Transparency International? Furthermore, how theseis data are is assembledrequires additional theory. Consider IHS, a UK-based research and consulting firm that publisheswidely-used country risk rankings. Their ranking is based on the following formula:

This risk ranking is calculated using a geometric mean: each risk is squared before it is weightedand then summed, and then the square root of the overall risk number is taken. The result is that afirm with a political risk ranking of 1 and an economic risk ranking of 3 (IHS rankings are out of5) ends up with a higher rating then a country in which both political and economic risk are rankedas 2. According to IHS, this formula penalizes countries whose single risk categories that exhibithigh variance.56That may or may not be a good decision, but IHS has clearly made a decision

based on an underlying theory about what makes a country more or less risky.

Furthermore, the IHS formula, like most risk rankings, is comprised of data selected byexperts and weighted according to expert opinion, experience, and observation, and thenaggregated, most commonly into a numerical or letter grade. Regardless of the data selected, thekey to a successful risk ranking is thus strongly subjective expert judgment, rather than a well-articulated underlying theory with guiding principles.57The IHS Political Risk variable, forexample, includes a sub category called Institutional Permanence, a measure of the maturity of a

political system; of course, maturity in the eyes of some is immaturity to others. Therefore, riskrankings are dangerous not merely because they are subjective in nature but because they presentthemselves as having a quantitative rigor they do not in fact possess. In the end, the most importantaspect in the creation of a risk ranking is the expert who created it and his or her judgment.

Moving Noncommercial Risk Assessment from a Focus on Environment to a Focus on

Stakeholders

Throughout the previous discussion of the shortcomings of noncommercial risk assessmentmethodology the weakness common to all methods was a confusion regarding the cause of a firms

54Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 8055William Louis Ascher, Limits of Expert Systems for Political-Economic Forecasting, Technological

Forecasting and Social Change36 (1989): 139.56James Auger and Farid Abolfathi, IHS Country Risk Methodology(London: IHS, 2013): 4.57Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 90

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Comment [LW77]: Isnt the point indices assume risk as given, and notinfluenced by what the firm does?

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Comment [LW78]: Why bury thisthis your main point?

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noncommercial risk. Because firms analysis fails to properly identify the root cause ofnoncommercial risk firms usually also fail to find an appropriate solution to mitigating the risk.The disjointed attempts by a firm to demonstrate that it is a social conscious through CSR

programs do not prevent noncommercial risks, that have little or nothing to do with a firm beingsocial conscious, from arising and thus leading to the inhospitable operating environments CSRefforts seek to prevent. The cause of noncommercial risk is how a firm operates in an environmentnot the environment itself, an oversight of most, if not all, noncommercial risk assessmentmethodologies.To address this shortcoming analysis must shift focus to the identification, evaluation, andassessment of stakeholders and stakeholder relationships. By reorienting the focus of analysisfrom the environment in which a firm operates to the stakeholders with whom a firm interacts afirms analysis guide a risk analysis determine how to navigate and shape the public and private

political and socio-cultural spheres in which they operate. Through this reorientation of analysisfirms can better account for the range of relationships, responsibilities, and interactions ofstakeholders they engage with. Such analysis will enable firms to prioritize and identify the keyrisks to their strategy and adjust accordingly. Finally, such an analytical shift changes the nature ofnoncommercial risks, it turns them from environment factors present in the operating environment

that are beyond the ability of a firm to address to risks that can be influenced through engagementand adjustments to corporate strategy.The implementation of stakeholder theory as a tool for understanding noncommercial risk requiresan understanding of why a stakeholder would take adverse action against a firm. Stakeholdertheory states that a stakeholder will seek to influence a firm as a result of an expectations "gap"

between the performance of a firm and the expectations of the performance according to thestakeholder. It is because of failure to identify stakeholder expectations that most CSR efforts failto create placid operating environments for firms. The gap is exacerbated over time, increasing therisk of adverse action by stakeholders over the lifecycle of a project. Identifying the underlyingexpectations of stakeholders should thus be at the root of a firms risk mitigation strategy. It thusstands to reason that the failure to satisfy a stakeholders expectations, not a firms project in and ofitself, is thus root cause of noncommercial risk.

A Sequenced Approach to Crafting CSR Strategies to Counter Noncommercial Risk

Addressing all of these issues in a static model is difficult, especially given the clear need forcontext-specific knowledge. As such, it is necessary to recognize that best practice can only ever

be a general road map and not a specific prescription, though as the interviewed stakeholdersabove noted, engagement must be formalized, structured, and professional in order to achievesuccess.Given these factors, we propose that the following five-step process be followed.

Firms must look inward and articulate clearly their own goals and strategy for a project.Firms must collect atmospherics/information on the local communities that their project is

going to affect. Firms must analyze and align project goals and strategy with the apparent social-cultural and political norms of the principal secondary stakeholders as much as possible; thisshould be done before a firm's strategy and plans are shared with the local community in order toreduce the perception of foreignness.

A firm should initiate engagement with secondary stakeholders in two ways: first witheducational activities exploring the nature of a projects industry, the timeline of typical projectsand the economic impact of projects on communities and secondly with project-specific updatesand town-hall style meetings that enable the collection of secondary stakeholder inputs on projectspecifics, these are listening meetings that must come after education. Sequence is important.



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Comment [LW80]: But the first st

have clear goals and strategy. Are ythe third step is to circle back and revthem??


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Finally, firms should review and prioritize the inputs, suggestions, demands, and potentialthreats from secondary stake holders, all should be prioritized based on impact on value creation ofa project for the firm. Some issues should be addressed in a direct and forthright manner; someissues will require changes to the plan, and other issues should be noted but dismissed (this is themost difficult category of issues). Once completed, the whole process should begin anew.

At all times every the affect and success of every effort should be measured and its progresstowards a predetermined goal should be measured. The repetitive nature of this process cannot beoverstated, it should be repeated as frequently as possible, with an emphasis on education andradical transparency, both of which will earn respect and increase the ease of conversion to a firms

position.

Additionally, if risk rankings were an effective measure of noncommercial risk,

rankings and corporate losses due to political risk, as a rough measure of a ranking's

accuracy, would correlate highly with a country's position in that risk ranking. This is not

the case, as was shown by Howell and Cheddick when they examined the correlation between

the rankings produced by the Economist Intelligence Unit/BERI Political Risk

Indices/Political Risk Services and a database of corporate losses from political causes. The

study found a very low correlation between the politi

short summery of thesis on local noncommercial risk

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