How to Bungle Political Risks

A survey finds that most senior executives consider overseas perils a low priority, even when they have investments and operations abroad.

AES’s management of its political risks in Georgia followed a common trajectory, according to Henisz. Often, companies make foreign investments during boom times, sign contracts they assume will protect them, and expect to be greeted with open arms, he said. When a recession, a chemical spill, or other possible negative events occurs, the host nation can view the foreign company as an outside enemy.

With oil prices soaring in recent weeks, many foreign companies involved in the energy industry have found themselves in hot water in host countries. Bolivia has decided to nationalize its gas industry, for example, and Venezuela changed contracts with international oil companies to garner a greater share of revenue. “The level of petro arrogance developing on the back of $65 oil and the willingness of government officials to squeeze more cash and preferable deals out of contracts with multinationals has been heightened,” observes Ian Bremmer, president of Eurasia Group, a New York-based political risk consultancy.

At the same time, political risk includes many other hazards, including political violence, expropriation, the inability to repatriate profits, and terrorism. The stumbling block for most multinational companies is setting priorities for managing potential problems, according to Bremmer, whose firm has linked up with PricewaterhouseCoopers to offer a political-risk-assessment service.

In fact, companies grant political risk low importance, even when they have investments and operations abroad. A September 2005 Protiviti survey of 76 senior executives at Fortune 1000 companies revealed that they ranked the importance of political risks in highly imperiled countries as “not significant, but monitoring for change.” The executives were more fearful of the risks involved in competition, regulation, the environment, technology innovation, and the financial markets.

To be sure, a PwC-Eurasia Group survey of 106 companies between December 2005 and February 2006 found that although 69 percent of companies gauge political risk as part of their financial projections for new investments. But once operations are established, only 27 percent create formal reports on those risks at least twice a year.

Companies also err by regarding the management of political risk as merely a matter of purchasing coverage for it. At Engelhard Corporation, however, managing these perils does not just revolve around buying insurance, according to Rich Sarnie, director of risk management. “You should be looking at loss prevention, have an awareness of what is going on in the country,” he notes, “all those are factors that need to be monitored on a daily basis.”

Every six weeks, Engelhard’s CFO gathers all business unit controllers to make sure the departments are aware of one another’s endeavors, the risk manager says. During those meetings, the risk management department shares political-event reports it subscribes to and examines investment opportunities, said Sarnie. The finance chief isn’t alone in his involvement: at 34 percent of the companies responding to the PwC-Eurasia Group survey, the chief financial officer pilots political risk management efforts.

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