PP 4 – Political, Legal, and Regulatory Environments

Question 1

Understanding the Political Environment: Risk Management Strategies

Answer 1

Localization
Partnerships
Insurance

Question 2

Localization:

Answer 2

Adjusting logistics and public relations in direct response to target market needs.

Customizing the product mix.

Altering Product attributes (packaging, warranty, client support etc.) to suit local tastes.

Question 3

Partnerships:

Answer 3

Effective for a long-term presence.

Can be informal or formal.

Question 4

Short-term;

Answer 4

select an agent or distributor.

Question 5

Long term – joint ventures for:

Answer 5

Local production.
‘Country-of-origin’ packaging.
Customer support.

Question 6

Insurance – to protect against:

Answer 6

Operational losses due to political risks such as war and terrorism.

Non-payment by foreign customers due to financial, economic and political uncertainties.

Question 7

Forms of Government

Answer 7

Ruled by one (monarchy or dictatorship).
Ruled by ‘the few’ (aristocracy or oligarchy).
Ruled by ‘the many’ (democracy).
Monarchy that runs as a democracy.
Dictatorship Monarchy that presents itself as a democracy.
Oligarchy that presents itself as a democracy.

Question 8

Political Risk

Answer 8

Executives often fail to understand political risk because they have not studied political science.

The ideal political climate for an international firm is a stable, friendly government. When the perceived political risk is high, a country will have difficulty attracting foreign direct investment.

Based on surveys of international businesses, political instability accounts for about 80% of the known variables when making the decision to expand internationally.

Some examples of political risk include:

–> War.
–> Social unrest, fractionized by language, ethnic and/or religious groups.
–> Changes in government/pro-business orientation.
–> Tolerated corruption and crime.
–> Tax and tariff discrimination.
–> Repatriation restrictions.

Question 9

Nationalization:

Answer 9

a government takes control of some or all of the businesses within a specific industry; foreign-owned assets are usually the first target.

This action is deemed as ‘Acceptable’ according to international law if it:
–> Satisfies a ‘public purpose’ (a perception).
–> Includes compensation (by what standards?).

Question 10

Taxes

Answer 10

Government taxation policies: excessively-high taxation leads to black market growth and promotes cross-border shopping and smuggling.
For example:
–> High taxes in Ontario leads to smuggling of cigarettes from the US.
–> Most Canadian provinces have laws that severely limit the amount of alcohol that can be transported across provincial borders.
–> China: many imports are subject to double-digit duties plus a 17 percent value-added tax. As a result, oil, cigarettes, photographic film, personal computers (as examples) are smuggled into China.

Question 11

Corporate Taxation

Answer 11

High taxes encourage many enterprises to engage in cash or barter transactions that are ‘off the books’ and sheltered from the eyes of tax authorities. This creates a liquidity squeeze that prevents companies from paying wages and local debts.

‘Earnings stripping’ refers to making loans to a foreign subsidiary rather than using direct investment to finance the business. The subsidiary can deduct interest on these loans to reduce its tax burden. It will also make the interest payments to the parent business; this action changes profits into operational expenses (to avoid government profit-transfer rules).

Question 12

Seizure of Assets - Expropriation:

Answer 12

Expropriation: a government takes ownership of land and/or assets from a foreign company or investor.

Under expropriation terms, compensation is provided. The problem; who defines the asset value?

Example: In 1959, Castro’s Cuban government:
–> Nationalized U.S. sugar companies’ properties.
–> Valued them based on declared tax revenue, not asset value.
–> Paid for them with Cuban government bonds.

Confiscation: no compensation is provided.

Question 13

Creeping Expropriation (Domestication):

Answer 13

defined as a multi-year change in the government’s policies regarding the rules for conducting business. This action usually ends with a loss of control (or a loss of the entire business).

A government’s most effective tools include:

1. Limits on returning profits to the home country.
2. Increased government business fees, tougher import rules, local content laws and local hiring quotas.
3. Discriminatory laws on technology as a requirement for getting business licenses.

Question 14

Country Risk Assessment Models - Target: India

Answer 14

Low to Medium Risk - what this means:

The Commercial Country Ceiling (CCC) Risk Rating is measured from low to high, and is meant to represent the best possible rating that can be assigned to a commercial business (obligor) in a country

Question 15

Strategies for Reducing Political Vulnerability

Answer 15

1. Joint Ventures
2. Expand the Investment base
3. Licensing
4. Planned Domestication
5. Political Contribution
6. Insurance

Question 16

Some Risk Assessment Common Factors

Answer 16

Government stability
Socioeconomic conditions
Investment profile
Internal conflict
External conflict
Corruption
Military in politics
Religious tensions
Law and order
Ethnic tensions
Democratic accountability

Question 18

Strategies for Reducing Political Vulnerability - Details

Answer 18

Joint Ventures: A joint venture with an established firm allows you to operate under a respected name. This action will minimize anti-foreign feelings and extends their ‘reputation’ to your business.

Expand the Investment Base: By financing your project through local (influential) investors and banks, you will have access to their political influence.

Licensing

–> Advantages:
1. Eliminates all shipping and tax costs (and risks) related to exporting activities.
2. Reduces production capacity demand at the home factory.

Disadvantages:
1. Potential misappropriation of your company’s technology.
2. A refusal to pay licensing fees while using your technology.
3. Material sourcing issues: (i) low-quality local alternatives, (ii) undercutting your price with your regular suppliers.

Planned Domestication

–> In cases where a host country is known to increase its influence in regard to control/ownership after the investor has made a long-term financial commitment, the most effective long-range solution may be a planned ‘phasing-out’ of ownership.

–> A common strategic model is to operate (and depreciate) the manufacturing equipment based on a schedule that aligns with the expected domestication date. The intent is to surrender the building/equipment when has no productive value.

Political Contribution: from a cultural perspective, it is defined as a bribe, gift, administrative fee, agent’s fee, ‘success’ fee, etc. The ethical issue related to this action is the culture’s definition of the transaction; is it an illegal bribe, or ‘business as usual’?
–> The intent is to lessen political risks by paying those in power to intervene on behalf of the foreign company.

Insurance: Export Development Canada (EDC) insures Canadian companies from certain foreign risks, including an inability to convert a country’s currency into hard currency, the risk of nationalization or confiscation, and the risk of political or personal violence.