Benjamin Graham University of Southern California IPES 2012...Factor Analysis Political Risk...

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

Benjamin GrahamUniversity of Southern California

IPES 2012

Political Risk and Experience Benjamin Graham

Puzzles

Political Risk Experience Benjamin Graham

Puzzles

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


Puzzles

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

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


Answers


Answers

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

tolerant


Answers

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

tolerant• Interesting Answers:

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

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


A 3-Part Typology of Political Risk

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

efficiency



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

policymakers• Measures: executive constraints and electoral accountability



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

physical integrity rights violations


Factor Analysis


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

Bureaucratic

Risk Policy Risk

War and Violence

Uniqueness

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

Theory

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

survival, no expansion


Theory (2)


Theory (2)

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

bribes into results


Theory (2)


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

individual firms to mitigate effectively


Theory (2)


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

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

mitigate• Use of violence is off the equilibrium path


Empirical Strategy


Empirical Strategy

• Unit = firm entry• New entries only


Empirical Strategy


• DV: level of risk in newly entered country


Empirical Strategy


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

t-1


Empirical Strategy



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

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


Empirical Strategy



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

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

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


Data: The U.S. Bureau of Economic Analysis



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




• Mandatory response




• Mandatory response• Confidential data



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

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

Host!Country!

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

Country!

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

Violence!in!New!Host!Country!

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

Bureaucratic!Risk!

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

Policy!Risk!

(mean)!

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

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

(mean)!

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

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

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

Number!of!

Observations!

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

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

!

Takeaways


Takeaways

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


Takeaways


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


Takeaways


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

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


Benjamin Graham University of Southern California IPES 2012...Factor Analysis Political Risk...

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