Political risk forecasting by Canadian firms

International Journal of Forecasting 6 (1990) 89-102

North-Holland

89

Political risk forecasting by Canadian firms

Gillian RICE and Essam MAHMOUD American Graduate School of International Management (Thunderbird), Glendale, AZ 85306, USA

Abstract: Improving the practice of political risk forecasting is of interest to managers of international firms. This paper deals with three important questions surrounding political risk forecasting: what to forecast, how to forecast, and how to implement a forecast. We present some results of a survey of Canadian firms’ political risk forecasting practices. The results generally support propositions and earlier findings reported in the literature. Comparing the results to those of American, French and Japanese studies suggests that there is a cross-national difference in information sources used for political risk forecasting.

Keywords: Forecasting, Social forecasting, Political risk forecasting, Implementation of forecasting, Inter- national applications, Empirical study.

Introduction

Developments in the theory and practice of political risk forecasting parallel those of forecasting in general. The literature reflects two themes. The first theme is the investigation of forecasting techniques. Decisions about techniques are related to the availability of data and the nature of the forecasting problem. The second theme is the investigation of how best to implement political risk forecasts. Several implementation issues are how a forecast can be made more useful to managers, and how the forecast can be integrated into the general decision making processes of the organization.

In this paper we discuss three important questions related to political risk forecasting: what to forecast, how to forecast, and how to implement a forecast. Following this discussion, we present some results of a study of Canadian firms’ political risk forecasting practice. Finally, we provide some recommendations for further research.

1. Political risk: What to forecast

Political risk forecasting can provide useful information for managers who must make decisions

such as how to enter a foreign market (exporting, licensing, joint venture, wholly-owned subsidiary, etc.), whether and how to extend credit to foreign customers, how to adapt product and promotional policies and how to price products and services. The question of what variable or variables to forecast, however, is an important one. The answer depends upon how one defines ‘political risk’. Kobrin’s (1979) and Fitzpatrick’s (1983) in-depth reviews of the literature provide details on various definitions of political risk. Kobrin emphasized that the impact of the political environment is industry, firm and even project specific. Not all firms are affected equally by certain forms of political change. This view corroborates Robock’s (1971) classification of political risk. He distinguished between ‘macro risk’ which occurs when unanticipated and politically motivated actions are directed at all foreign enterprise and ‘micro risk’ which occurs when such actions are intended to affect only selected business activity. Political risk can be the probability of one particular event occurring or of a class of events occurring. Exam- ples of macro risk are revolutions, coups d’etat and mass expropriations. Examples of micro risk are import and currency controls directed at specific industry sectors. Kobrin (1984) observed that the occurrence of expropriation has declined

0169-2070/90/$3.50 0 1990 - Elsevier Science Publishers B.V. (North-Holland)

90 G. Riw, E. Mahmoud / Polttical rrsk Jorecustq by Candian Jrmts

dramatically since 1976, and has been replaced almost everywhere by increased legislative controls upon business.

Some years ago, Robock (1971) made an important distinction between political instability and political risk: “political fluctuations which do not change the business environment significantly do not represent risk for international business.” Decision making procedures in international firms might improve if we could identify factors associated with political risk. Several recent research studies make important contributions in this context. These studies are discussed next.

1. I. Political instubility and politicul risk

One group of research studies, conducted by Schollhammer and Nigh (1984, 1986) and Nigh (1985. 1986) focuses on identifying economic and political determinants of American, Japanese and German direct foreign investments. In general, the results suggest that while political instability within a country may have some bearing on political risk, international political conflict and cooperation (as defined in The Conflict and Peace Data Bank (COPDAB) Project (Azar, 1980)) may be more important. This suggests that political risk forecasters place some emphasis on international (as opposed to intranational or G&in-country) political conflict and cooperation. The importance of relationships between nations is illustrated by the planned integration of the European Community (EC) in 1992. This is anticipated to have far-re- aching effects on businesses based within the EC as well as overseas. This is also an example of cooperation between nations where much uncertainty about the outcome remains.

1.2. Policy instability and political instability

A manager is usually concerned with political risk in terms of governmental policy instruments such as exchange controls and tax policies. Brewer (1985a) investigated whether policy instability is associated with political instability. His findings expose the inadequacy of regime change, an intranational measure of political conflict, as a sur- rogate indicator of political risks. The evidence suggests that political instability (regime change) in eight large developing countries does not necessarily translate into instability in the fiscal policy

in those countries and, therefore, into political risk for businesses.

Policy formulation is, of course, a function of economics as well as of politics. Juhl (1985) and Pollio and Riemenschneider (1988) argued that the Third World governments behaved in an economically rational way when they expropriated and nationalized investments in the 1960s and 1970s. The behavior was motivated by economic rationality rather than, as commonly assumed, political instability. Juhl (1985) explained that selective expropriations occurred because “foreign investments [had] ceased to contribute to the host country’ s economic development more than com- parable domestic firms could contribute”.

The separation of economics and politics in academics is arbitrary. Many political controver- sies, however, concern economic issues and thus politics and economics in real life are inseparable (Overholt, 1985). Furthermore, Ascher (1982) argued that politics is inextricably linked with social forces. He stressed that one requirement for the political forecaster is to identify social trends which: (1) change the priority of issues facing the body politic: (2) change the resource bases of different political actors (for example, increase wealth or prestige which can be converted into political leverage): and (3) activate different political dynamics than those currently prevailing. Hence, when forecasting political risk in terms of policy change, managers should monitor key economic and social variables as well as political variables.

1.3. Politicul risk us opportunity

In recent years many countries such as ln- donesia, Malaysia, Turkey, Egypt. India, and Canada have liberalized their investment codes for foreign firms. Political risk forecasters should con- sider such positive political developments which represent opportunities for business, and not only the negative developments. As David (1985) emphasized, in financial analysis the term risk is neutral, implying both positive and negative variations from the mean. He further noted that the interpretation of political risk as having negative connotations is a sociocultural phenomenon. American business culture assumes an adversarial relationship between business and government. In other countries, such as Korea, Japan and India,

G. Rice, E. Mahmoud / Politmxl risk forecasttng by Canadian firms 91

the relationship between business and government reflects a partnership.

Regardless of the particular kind of relationship between business and government, however, political risk forecasting should include considera- tion of the firm’s home country environment as well as foreign country environments. For example, export controls (which are imposed upon a firm in its home country environment) have be- come increasingly important as instruments of foreign policy (Sethi and Luther, 1986). An ex- porter could lose a market if his/her own government forbids the sale of his/her goods to that particular market. Export controls can be imposed at the macro level applicable to all firms (as in the case of sanctions), or at the micro level, to control ‘strategically important’ goods.

1.4. Developed versus developing countries

It is important to focus on forecasting politically relevant developments in industrialized countries. Much emphasis has been placed upon developing countries. Yet, studies by Scholl- hammer and Nigh (1986), Brewer (1983) and Cos- set and de la Rianderie (1985) have found relationships between political risks and direct investment, factional regime change and policy instability, and unanticipated political events and currency movements, respectively, all for industrialized countries.

1.5. Political events versus the political process

Fitzpatrick (1983) considered current definitions of political risk to be unsatisfactory because they constituted political event risk. He defined political risk in terms of process variables rather than events variables. Ascher (1982) also emphasized the dynamics of political interaction, from which events emerge. He argued that is easier to predict the nature of a confrontation or to under- stand how political forces interact, than to predict winners or losers. In any case, predicting winners or losers does not necessarily allow a firm to predict policy changes (see Brewer, 1983, 1985a).

To summarize the discussion on what should be forecast, some general quidelines are the following:

(1) The political risk forecaster should pay careful attention to inter national conflictive and cooperative events and processes.

(2) Political instability (in particular, regime change) does not necessarily result in policy insta-

bility. (3) A political risk forecast should include con-

sideration of events and processes resulting in business opportunities, as well as in adverse circumstances.

(4) Political risk forecasts are important for industrialized countries as well as developing countries.

(5) The emphasis in political risk forecasting should be on understanding political processes (the nature of interactions and the important issues). There should be in-depth understanding of all forces at work in the political process, in particular, social and economic forces.

Hence, political risk for a firm can be defined as intranational and international conflictive and cooperative events and processes that may or may not result in governmental policy changes at home or in foreign countries and that result in adverse circumstances or opportunities (concerning prof- its, markets, plant and personnel, for example) for the firm.

2. Political risk: How to forecast

The preceding discussion of what to forecast for political risk suggests that a political risk forecast should be comprehensive. Previous studies have dealt with developing or improving forecasting techniques (see Austin and Yoffie, 1984; Moran, 1985; Overholt, 1985; Coplin and O’Leary, 1985; Shreeve, 1985). Others have provided de- scriptions of individual firms’ approaches (see Morgan, 1985; Mark, 1980; Sassi and Dil. 1983). Rice and Mahmoud (1986) presented a procedure for selecting the most appropriate technique.

Quantitative techniques can be used to model political risk. Brewer (1985b) illustrated the value of time series analysis in a study of government policies in Turkey. A major problem of quantitative approaches is that, at some stage of the analysis, measurements have to be applied to critical variables. The assumptions on the basis of which these quantitative measurements are assigned are not always clarified. The use of quantitative measurement therefore often lends a degree of authenticity and authority to a forecast which is based solely on judgment. Another measurement

92 G. Rice, E. Mahmoud / Political risk forecastwg Ly Canadian firms

problem occurs due to aggregation of political events, (for example, riots, assassinations, regime changes). Not every riot has the same causes nor does it have the same effects, if any. for political risk to a firm (see Sassi and Dil, 1983; Ascher, 1982).

It seems to be an emerging view that judgmental methods, like scenarios or panels, are the pre- ferred ways to forecast political risk (Ascher, 1982; Overholt, 1985; Coplin and O’Leary, 1985; Shreeve, 1984, 1985). Ascher (1982) noted that the distinctive nature of politics requires methods like systematic scenarios that cope with political complexity through their comprehensiveness rather than through their explicitness and quantification.

Panels of experts are also commonly used to produce commercially available political risk forecasts (see for example, Coplin and O’Leary, 1985). Mumpower et al. (1987) obtained ratings of political risk by naive judges (students) similar to ratings produced by members of the Association for Political Risk Analysis. This result, compatible with findings generally that novice judges rival experts, raises the question of whether managers should do their own forecasts rather than relying on ‘experts’. Although the students in the Mumpower et al. study received no formal train- ing, it was not clear whether or not the researchers controlled for information input, the time taken to provide the judgment and the subjects’ confidence in their results.

One difficulty in forecasting which is particu- larly apparent in political risk forecasting, is the prediction of turning points. Experts are unable to predict turning points and quantitative methods do not do much better (Grosse, 1985). Accuracy in political risk forecasting may be improved by using a combination of techniques. Combining may al- leviate difficulties by capitalising on advantages inherent in each method being combined (Mahmoud, 1984). Overholt (1985) suggested the use of leading indicators in conjunction with scenarios as this may signal a possible turning point before either method used alone would do so. Time series analysis may be appropriate for forecasting some variables; other variables may be forecast using scenarios and panels (Brewer, 1985b). The results could then be combined. Morgan (1985) described one bank’s approach to combining quantitative and qualitative forecasts of country risk.

3. Political risk: Implementing forecasts

Forecasting is a decision-specific task. A key to implementation is bridging the gap between the forecast and managerial decisions; that is, making the forecast company-specific and even project- specific. For example, if firms purchase general reports about business-related political developments overseas from organizations such as Frost and Sullivan. these reports will be inadequate un- less supported by detailed interpretation for an individual firm (Rice and Mahmoud, 1986). De la Torre and Neckar (1988) thus propose a two stage process in their framework for political risk analysis. The first stage is an examination of national characteristics (economic, social and political forces) in the country of interest. The second stage consists of “bringing into sharper relief the fea- tures of the business project that either increase or diminish the possible negative consequences of each event” (De la Torre and Neckar, 1988).

Schultz (1984) summarizes the most constant predictors of forecasting system success or failure as management support, user involvement, and the implementation process itself. Political risk forecasting must have top management acceptance (Shreeve, 1984). Employees must also be motivated to contribute to and use the forecast. This acceptance and motivation must occur before political risk forecasting is formally begun in an organization.

The nature of political risk forecasting (examin- ing linkages between socio-economic and political forces) tends to mean a reliance on judgmental analysis. Kobrin (1982) found that judgmental forecasting of political risk was most popular among managers. Therefore, there is a need to control for bias in forecasting. The use of judgmental analysis, can, however, mean that managers have more confidence in their projections and are thus more likely to use them in decision-making (Evans. 1987).

The next section of the paper discusses the results of a Canadian study of political risk forecasting.

4. Results of a Canadian study of political risk

forecasting

The objective of a Canadian study was to examine the political risk forecasting practices of

G. Rice, E. Mahmoud / Political risk forecasting by Canadian firms 93

Canadian firms involved in international business. The population selected for study comprised all the manufacturers of industrial products, financial insiitutions, consulting engineers and construction firms listed as members of the Canadian Export Association (CEA) in 1983. This population included 280 exporting and international service firms. A questionnaire was mailed to the CEA contact person for each of the 280 firms. One hundred and five responses were received. Dis- counting questionnaires returned because of dis- continued operations (19) and because of no overseas business (7), that is, representing firms outside of the sampling frame, the response rate was 41 percent. This response rate might have improved with a follow-up mailing. Lack of funds prevented this. Telephone enquiries obtained reasons for non-response from 17 percent of the nonrespondents. The most common reasons were that “the level of international business done was not enough” or that “no political risk analysis was done”. Factors encouraging response might have been interest in and knowledge of the topic. The somewhat low response rate, although not unusual for mail surveys of businesses, could be a source of nonresponse error. However, some studies (Weaver et al., 1975; Dreher, 1977; Gough and Hall, 1977) found that a low response rate does not automatically mean that there has been significant response error. Leslie (1972) concluded that “when surveys are made of homogeneous populations (persons having some strong group identity) concerning the group, significant response-rate bias is probably unlikely”.

Other possible sources of bias in the study include the following. Non-members of the CEA were not included and their perceptions and practices related to political risk forecasting may differ from those of CEA members. It may not therefore be possible to generalize the results of the study to other Canadian firms. There could be response bias because of lack of control over who com- pleted the questionnaire. This bias is likely to be small, however, as in over 50 percent of cases the respondent identified himself or herself as a vice- president or president and another 37 percent were at the managerial level, the majority in the marketing or sales functions. These respondents can be expected to have knowledge of their firms’ practices and policies for political risk forecasting. Item non-response was not a major problem and

many respondents supplemented their responses with detailed explanations.

Respondents belonged to a variety of industrial

sectors, for example, chemical, machinery, textiles, and office equipment. Industrial products firms represented 60% of respondents, engineering consulting firms represented 18%, financial institutions, 12% and construction firms, 9%. Using a hypothesis test for a multinomial situation and using the &i-squared statistic, there is no evidence to suggest that the sample of respondents differs from the population on the basis of firm type (manufacturers, consulting engineers, etc). Be- cause of the limited information provided in the CEA listing, it was not possible to check sample representativeness using any other variable. The characteristics of responding firms are shown in exhibit 1.

We felt it was important to investigate political risk assessment by exporters and service firms as well as by firms involved in direct foreign investment. Previous studies by Marois (1979), Kobrin (1982) and Yasumuro (1984) focused primarily on foreign investors. Exporters are vulnerable to

Exhibit 1 Characteristics of responding firms

Global sales (including domestic) Percentage of in last financial year (1983) a firms (n = 74) h

Less than $lm 7

$l.lm~lOm 20

$lO.lm-50m 26

$50.lm-200m 26

Over $2OOm 22

Percentage of sales generated abroad Percentage of

firms (n = 95) h

O-10 19

11-25 22 Over 25 60

Number of countries in which Percentage of firm is operating firms(n=lOO)

l-4 25 5-11 34 Over 20 41

Years of overseas experience Percentage of firms (n = 98) h

Less than 5 years 3 5-14 years 31 Over 15 years 67

a Figures are in Canadian dollars.

’ Percentages do not add to 100% because of rounding.

94 G. Rice. E. Mnhmoud / Political risk forecccsting hv Canudwz firms

market loss and loss of payment although it is true that they can transfer much risk to government export credit agencies or banks. Rice (1982), in a study of British exporters, found that product prices, sales volume and profit margins in a market were associated with the level of perceived political risk in that market.

The research findings of the Canadian study are presented with respect to the three questions discussed earlier in the paper: what to forecast, how to forecast, and how to implement a forecast.

4.1. What to forecast: respondents’ perceptions of

political risk

The question of what to forecast in the political environment is intuitively linked to the managers’ perceptions of what constitutes political risk. We asked respondents to indicate and rank the most important aspects of the political environment in terms of their impact upon business operations. The results are presented in exhibit 2. Respon- dents indicated that “political or social unrest” was “most important” in less developed countries. Both our respondents and Kobrin’s (1982) considered this variable to be less important in industrialized countries.

Import restrictions, ranking number four in less developed countries, ranked number one in developed countries. Canadian managers ranked import restrictions higher than did respondents in other studies (see Kobrin, 1982; Marois. 1979). This might be because our sample is comprised more of exporters and service providers than of direct foreign investors. In Rice’s (1982) study of British exporters, in response to an open-ended question, managers mentioned protectionism and governmental change as the two most common factors contributing to political risk.

Our results support the argument that it is desirable to distinguish between political risk forecasting in less developed and industrialized countries. Managers are concerned with different political variables in each group of countries. As Kobrin (1982) noted, in industrialized countries respondents are generally less concerned about civil dis- order, war, and expropriation than about specific managerial contingencies. For the Canadian respondents these contingencies were import restrictions, industry specific problems, and currency or remittance controls. Therefore, with respect to the

Exhibit 2 Importance rankings of political environmental aspects

Political environmental aspects Percentage

of time the

aspect

was ranked

“1” or “2” a

In less developed countries:

Political or social unrest

- Currency or remittance control

- Risk of expropriation.

31.2

32.9

confiscation or nationalization

Import restrictions

Employee safety

Taxation

- Contract problems

- Local ownership requirements

In developed countries:

- Import restrictions

- Industry specific problems

Currency or remittance control

- Political or social unrest

- Contract problems

Labor problems

- Local ownership requirements

Risk of expropriation,

16.2

13.3

10.5

10.5

9.5

5.8

20.0

18.1

15.3

12.4

10.5

9.6

8.6

confiscation, or nationalization 8.6

a Respondents were asked to select the five most important

political-environmental aspects from a list of seventeen and

to rank them according to their potential impact on their

firm’s overseas operations. “1” = most important and “5” =

least important. This was done for less developed and devel-

oped countries. using the same list of aspects.

question of what to forecast, the forecasting of specific policies is perhaps most important. Fore- casting policy changes means that the forecasts can more readily be viewed as managerially relevant.

4.2. How to forecast: Respondents’ use of forecasting

methods

Personal judgment was by far the most used political risk forecasting ‘method’ (see exhibit 3). In this respect, this study confirms the findings of earlier studies. Kobrin found that 46% of his respondents used any qualitative method compared to 19% who used any quantitative method. Yasumuro’s (1984) Japanese respondents also rated qualitative techniques as important much more often than they did quantitative techniques. Personal judgment also has the highest mean self- reported success rate relative to other methods

G. Race, E. Mahmoud / Politmd risk forecasting by Canadian /inns 95

Exhibit 3 Use of political risk forecasting methods

Method Firms that have used Mean

method (n = 105) success

Number Percentage score a.h

Personal judgment 83 79.0 2.578 (P,)

Structured qualitative 24 22.9 2.042 w)

Standardized checklists 28 26.7 I.964 (~3)

Investment models 15 14.4 I.867 (~4)

Scenario development 31 30.0 I.833 (PLg)

Statistical analysis 29 27.6 I.828 (&)

Delphi technique 7 6.7 I.286 (~7)

’ I = used but with no success; 2 = used with a moderate

degree of success; 3 = used with a great deal of success. h Using Fisher’s Least Significant Difference Procedure indi-

cated the correct relative ordering of the mean scores to be (at the 0.05 level of significance): p, > p2 = pL, = p4 = ps = ps

’ 1*7-

(see exhibit 3). This suggests were generally satisfied with political risk forecasting.

that the managers this approach to

The second most popular method used by the Canadian firms was ‘scenario development’. Its reported success rate was less than that for personal judgment. In terms of the mean reported success rate, the Delphi technique ranked lowest. Applying Fisher’s Least Significant Difference (LSD) procedure indicated that on the basis of reported success, the forecasting methods formed three groups. The first group consisted of personal judgment. The second group comprised statistical analysis, scenario development, investment model, standardized checklist and a structured qualitative approach. Within this group there was no significant difference among these methods’ success scores. The third group consisted of the Delphi technique. There was a statistically significant difference at the 0.05 level between the mean success scores of all three groups (see exhibit 3 for details).

We investigated what specific problems managers face in political risk forecasting. Under- standing these problems could suggest directions for improvement. We asked the Canadian respondents to rate the magnitude of each of six problems identified by Mascarenhas and Atherton (1983). Exhibit 4 presents the results.

The biggest problems in political risk forecasting for the Canadian managers were “the assessment process tends to be reactive, not proactive” and “unreliable data”. An application of Fisher’s

LSD procedure indicated that there was no statistically significant difference in the mean magnitude scores for these two problems. These formed the first of three groups of problems identified by the LSD procedure. The second group included “lack of skills required for effective assessment”. There was a significant difference at the 0.05 level between the magnitude scores for the first and second groups. The third group contained the problems “delay in preparing reports”, “distortion of information as it moves through the organization” and “no apparent top management support for assessment unit”. There was a statistically significant difference at the 0.10 level between the magnitude scores for the second and third groups (see exhibit 4 for details). In terms of relative problem magnitude, the findings confirm those of Mascarenhas and Atherton (1983).

Fifty-seven percent of the 105 respondents provided reasons for their choice of political risk forecasting method. On the whole, these respondents seemed to experience frustration in using the various methods available. They either prefer to rely on personal judgment rather than on any sophisticated methods, or else they indicate that the degree of success obtained by using various other methods is rather moderate. Some firms choose to transfer the function of political risk assessment to government agencies (primarily the

Exhibit 4

Problems in assessing political risk

Problem Mean score a.h

The assessment process tends to be

reactive, not proactive (n = 70) 2.700 (p,)

Unreliable data/information (n = 72) 2.694 (,u2)

Lack of skills required for

effective assessment (n = 75) 2.311 (p,)

Delay in preparing reports (n = 69) 1.928 (/A~)

Distortion of information as it

moves through the organization (n = 67) 1.821 ()I~) No apparent top management

support for assessment unit (n = 63) 1.762 (p6)

a Respondents rated the importance of the problems on a

five-point scale where “1” represented “not a problem” and

“5” represented “big problem”.

’ Using Fisher’s Least Significant Difference Procedure indi-

cated the correct relative ordering of the mean scores to be

p, = p’z > px > p(4 = pLs = p6. It should be noted that there is a difference between px and p4 at the 0.10 level of signifi-

cance and between p, and the other mean scores at the 0.05 level of significance.

96 G. Rice, E. Mahmoud / Polrtrcal risk forecasting by Canadmn fwms

Export Development Corporation) and capital lending agencies such as banks.

A majority of the respondents stressed experience as the justification for relying on personal judgment. Representative comments included “personal judgment is as good as any of the other methods if the person making the judgment is experienced” and “experience has been our best teacher”. There are dangers in relying on personal experience, however. Marois (1982) suggested that managers who relied on their personal experience abroad may be too confident of their own opin- ions, which in the worst case may be only of historic value. This view conforms to other studies on judgment, such as Evans (1987), Kahneman, Slavic and Tversky (1982) and Fischhoff and Mc- Greggor (1982).

One fifth of the Canadian respondents reported that their firms were taking steps to improve methods of political risk forecasting. These firms were more likely than others to be using statistical analysis or investment models. The ways in which evaluations are being improved center on information and communication. Kobrin (1982) emphasized the need to improve managerial skills in processing information. He indicated that “the scarce resource is not information but the ability to process it”.

4.3. How to implement a forecast: Respondents’ organization and use of political risk forecasting

Seventy-five percent of the firms in the Canadian study assessed political risk using internal expertise. One firm subcontracted the task to an outside organization and did no assessment in-house. Twenty-four percent of the firms subcontracted the job of political risk assessment to outside organizations as well as tackling it in- house. These findings are similar to those of Marois (1982) for French firms. Internal assessment of political risk makes sense when the significance of industry or firm specific risks is taken into account. The difficulty with forecasts produced by commercial political risk analysis services is that they may not be relevant to a specific managerial decision. Another factor to be considered is the cost of purchasing such forecasts.

The commercial risk assessment services of Business International (BI), Business Environment Risk Information (BERI) and Frost and Sullivan’s

World Political Risk Forecasts (WPRF) were used by only 18% percent of the sample, with 5.7% using more than one service; 8.5% used BERI, 11.4% used BI and 5.7% used WPRF. Other outside organizations were used by respondents. These include banks and government agencies (mentioned most often) insurance companies, industrial associations and consultants. The tendency is, however, for political risk forecasting to be done internally rather than externally.

For the Canadian respondents, political analyses are carried out most often (by 81% of respondents) ‘on demand’, that is, in an ad hoc fashion, in response to a pending market entry, investment proposal or an important event in the country. For example, one large multinational in our sample set up a special unit in France to deal with a problem in Africa. In this respect the findings of the Canadian study were very similar to those of the Japanese and American studies. While ‘on demand’ analyses are, by definition, relevant to a firm’s operations, such analyses also perpetuate the reactive, rather than proactive, approach to forecasting. Nevertheless, 21% of the firms reported carrying out routine analyses as well as analyses on demand. Several respondents emphasized the need for continuous attention to political factors: “analysis should not be a a ‘stop and go’ exercise”, recommended one respondent. Twenty-three percent of the respondents reported ‘rarely’ carrying out political analyses.

For political forecasting that is done internally, a variety of departments and levels of management are involved. Only three firms had a special- ized unit for political assessment (a major bank and two engineering consulting firms). Like Kobrin (1982), we found that firms without spe- cialized units tended to locate the political risk forecasting function at upper levels of management. For 66% of the firms in our study, top management is involved in the assessment process. The corresponding percentage in Kobrin’s (1982) study is 73%. The Japanese study also demon- strated the importance of top management in political analyses. Undoubtedly, only in a very small number of firms is political risk forecasting distinguished as a separate function of management. We expect that some firms will differentiate the function (as suggested by Kobrin’s and Yasumuro’s studies). For most firms and for some time to come, however, political risk forecasting

G. Rice, E. Mahmoud / Political risk forecasting by Canadian firms 97

will remain part of the responsibilities of the international division or top management.

Clearly, there are resource constraints on the implementation of political risk forecasting. For example, a respondent from a bank gave this opinion: “for the most part, banks have executive

level personnel involved in country risk assessment and it is a highly technical process. Whereas with companies, very often it is a ‘seat of the pants’ exercise because they just do not have the resources and expertise to devote to this very time consuming exercise”.

The most popular occasion for use of political analyses was “when granting credit to foreign customers”, mentioned by 42 percent of the re-

spondents (see exhibit 5). This could account for the ad hoc nature of evaluations. The result from the Canadian study contrasts with the findings of Marois (1979), Kobrin (1982) and Yasumuro (1984). Their results suggested that an initial investment decision was the most frequent reason for use of political analyses. This discrepancy is most probably a function of the samples. Ours was derived from an export association member- ship list. The other samples included more firms with overseas production facilities.

The relative importance of different informa-

tion sources for the success of a firm’s political risk assessment effort is shown in exhibit 6. The majority of firms considered several sources of information to be important. This suggests that multiple sources of information are used in political risk forecasting. The use of Fisher’s LSD procedure revealed six groups of information sources according to the relative importance of each. There was a statistically significant difference at the 0.05

level between the importance scores of all six groups. The first group included corporate headquarters personnel, banking community and Canadian embassies. The second group consisted

Exhibit 5 Use of political risk evaluations

Occasion of use

When granting credit to foreign customers

Day-to-day operations Initial foreign investment

decision Strategic planning

Number of mentions

44 21

16 15

Exhibit 6 Relative importance of information sources for political risk forecasting

Information source Mean importance score a.b

Corporate headquarters personnel (n = 90) 3.744 (PI)

Banking community (n = 93) 3.666 (pZ) Canadian embassies (n = 88) 3.579 (/+) Regional managers (n = 79) 3.316 (pLq) Agents (n = 83) 3.096 (c(~) Subsidiary managers (n = 73) 3.000 (&) Canadian government

domestic agencies (n=86)2.942(/+) International organizations (n = 82) 2.842 (ps) Trade associations (n = 88) 2.705 ( ps) Other firms (n = 81) 2.593 (P,~) Business/trade periodicals (n = 72) 2.500 (IL,,) Newspapers, radio, television (n = 82) 2.402 ( plZ) External consultants (n = 78) 2.141 (P,~) Canadian Chamber of Commerce (n = 78) 2.051 &) Professional/academic journals (n = 67) 1.955 (/+,) Academics (n = 78) 1.628 (p16) Journalists (n = 77) 1.571 (PI,) Local stock market activities (n = 75) 1.493 (pls)

a For each of the listed information sources, respondents were asked to rate its importance to the success of their firms’ political risk assessment effort, on a scale from “1” to “5” where “1” =“not important at all” and “5” =I‘ very important”.

b Using Fisher’s Least Significant Difference Procedure indicated the correct relative ordering of the mean scores at the 0.05 level of significance to be: CL, = pZ = p3 > p4 = p5 = p6

’ p7 = CL8 = p9 ’ k0 = h1 = k2 ’ h3 = h4 = ,-%5 ’ h6 = PI7

= PlS.

of regional managers, agents and subsidiary managers (details of these and the remaining groups are provided in exhibit 6).

A difference between our results and Kobrin’s emerges. Our results show three types of internal

information sources (headquarters personnel, regional managers and subsidiary managers) ranked 1, 4, and 6, respectively. In Kobrin’s study, the American respondents placed these sources in the first three ranks. For our Canadian respondents, the banking community and Canadian embassies are considered more important. Japanese respondents (see Yasumuro, 1984) also rated banks and embassies as more important than did American respondents. The reasons for this reliance on external sources of information may be because the Canadian sample contains relatively more exporters than multinationals with overseas sub- sidiaries. Keegan (1974) found that the most often

98 G. Rice, E. Muhmoud / Pobrical risk fr,recusting by Cancrdiun firms

used information sources overseas were sources revenue forecasting, Bretschneider and Gorr (1987) inside the multinational enterprise. The Japanese tested a model of forecasting accuracy that in- sample included a majority of multinational firms, cluded organizational and environmental varia- however, as well as banks, general trading compa- bles. Following their approach, we identified and nies and retailers. tested this model:

Another reason for the reliance of these firms on external sources may be that the banks are relatively larger and more concentrated in Canada with well developed information services. Banks

were also mentioned frequently by respondents as an external source for political risk assessment services. The Canadian government takes on a much more active role in the economy than the U.S. government, so rank 3 for the embassies compared to rank 8 in Kobrin’s U.S. study should not be surprising. In comparison with the Ameri- can context, Japanese business and government also represents even much more of a ‘partnership mode’ than does the Canadian experience in international business development.

PERCEIVED SUCCESS SCORE

USING A PARTICULAR

FORECASTING METHOD

= ~(IN-HOUSE ANALYSIS, FIRM TYPE,

IMPORTANCE OF INFORMATION

SOURCES, SIZE OF FIRM,

OVERSEAS EXPERIENCE OF FIRM).

The model is a formal attempt to account for organizational and environmental effects on the perceived success of political risk forecasting.

We estimated the models for four selected forecasting methods (standardized checklist, scenario, statistical analysis and personal judgment) using the stepwise regression procedure. IN-HOUSE analysis of political risk and FIRM TYPE (industrial products, engineering consulting firms, financial institutions and construction firms) were coded as dummy variables. SIZE OF FIRM was measured in Canadian dollars and OVERSEAS EXPERIENCE in years. IMPORTANCE OF INFORMATION SOURCES and PERCEIVED SUCCESS were measured using five point and three point scales respectively (see exhibits 3

5. Factors contributing to success in political risk

forecasting

The identification of factors that have an impact on the success of political risk forecasting would be an important contribution to this field of study. In the case of state and local government

Exhibit 7

Models of factors contributing to success in political risk forecasting

1.608 1.141 0.002 0.002 0.35 27

Dependent

variable

Perceived degree of

Success using

STANDARDIZED

CHECKLISTS

Independent

variables

IN-HOUSE

ANALYSIS

Inter-

cept

0.645

Beta

coefficient

0.666

r pr”b F pr& R2 n

0.006 0.019 0.225 24

Perceived degree of

Success using

STATISTICAL

ANALYSIS

FIRM TYPE:

FINANClAL

INSTITUTIONS

Perceived degree of

Success using

SCENARIOS

Perceived degree of

succeSS using

PERSONAL

JUDGMENT

- ANALYSIS

ON DEMAND 1.407 -0.586 0.014 0.008 0.306 29

- IMPORTANCE

OF ,NFORMATION FROM

BANKING COMMUNITY 0.226 0.035

SIZE OF

FIRM 2.649 -0.0032 0.023 0.038 0.11 46

G. Rice, E. Mahmoud / Political nsk forecasting by Canadian firms 99

and 6 for details). Multicollinearity between the independent variables was not problematic. The results of this regression analysis are presented in exhibit 7.

All four estimated regression models have low values of R-squared. Yet, the overall F-tests and the individual coefficient t-tests are significant at the 0.05 level or better. This implies that the models do have explanatory value. The PERCEIVED

SUCCESS OF USING STANDARDIZED CHECKLISTS iS

associated with IN-HOUSE analysis. Perhaps standardized checklists developed and used in-house as opposed to those from external consultants or other outside organizations means that the political risk analysis is more relevant and of more value to firms. Hence, there is a positive relationship between in-house analysis and perceived success.

The success of STATISTICAL ANALYSIS is related to its USC in a partkdar FIRM TYPE, FINANCIAL

INSTITUTIONS. This is most likely due to the nature of the data available to financial institutions as well as the higher levels of statistical expertise in those organizations.

ANALYSIS ON DEMAND is negatively related to success in using SCENARIOS. An explanation for this could be that scenarios are not a good forecasting tool to use on demand. Ascher (1982), for example, has advocated that scenarios be imple- mented in a systematic and comprehensive way. IMPORTANCE 0~ INFORMATION FROM BANKING

COMMUNITY is positively associated with the suc-

cessful use of SCENARIOS. This finding and our

result showing the importance of banks as infor-

mation sources in general suggest that banks provide information that is crucial for good political assessment. Mumpower et al. (1987) argued that only three factors are needed to predict political risks. Two of these factors are financial: exchange rate differential and estimated inflation rate.

The fourth estimated equation deals with PER-

SONAL JUDGMENT. SIZE OF FIRM is negatively re-

lated to success. As a firm increases in size and its

operations increase in complexity, it seems that

some structure in the area of political risk fore-

casting is desirable. Indeed, Kobrin (1982) found that large international firms in the latter stages of the evolution of a global strategy are significantly more likely to have assigned explicit responsibilities for political assessment and to begin to sys- tematize its performance.

Although this investigation of the factors contributing to success is exploratory and much more research remains to be done, the results suggest that certain environmental and organizational factors are related to success in political risk forecasting.

6. Discussion

The objective of this discussion is to summarize the main findings of the study. We also suggest future directions for research.

The results pertaining to perceptions of risk imply that in determining what should be forecast there should be a distinction between the kinds of risks in developed and developing countries. In developed countries, the Canadian respondents were most concerned with policies towards exporters and foreign investors rather than with political instability. Policy change is also important in developing countries, however. Hence more research is needed in improving approaches to forecasting specific policy changes rather than some broad concept of political risk. Scholl- hammer and Nigh (1984, 1986) have shown the significance of international conflictive and cooperative events on direct foreign investment. Is this because these events result in specific policy changes? The recent experience in U.S.-Pan- amanian relations might be useful for investigation in this sense.

Concerning how to forecast, the literature tends to advocate the use of structured qualitative approaches to political risk forecasting. There also is potential for improving performance through the combining of techniques. Most of the Canadian respondents rely on personal judgment to evaluate the political environment. While they report using some kinds of structured qualitative approaches, these are probably not applied in a very ‘structured’ way. For example, the regression analysis suggests that an ‘on demand’ approach to scenario analysis might not contribute to the successful use of that method. No information was collected on practice in combining techniques. This could be a fruitful area of research in the future.

The survey results suggest a concern on the part of respondents for improving information processing, especially for the use of statistical methods. One issue treated in depth in the litera-

100 G. Rice, E. Mahmoud / Political risk forecasting by Canadian firms

ture is how to quantify information for political analysis. The argument centers on the question of whether political information can be quantified and remain meaningful and useful. The answer to this question lies in the record of political risk forecasting. Further research should examine care- fully the performance of various techniques over an extensive period of time. To extend the exploratory analysis in this paper, research should investigate the factors contributing to successful forecasting. Attention should also be paid to the best way to define ‘success’ in political forecasting. In the Canadian study the measure used was subjective rating of success. As with any subjective measure this is subject to bias. On the other hand, perception of success rather than a statistical accuracy measure may be a more important determi- nant of the use of a particular approach. Once ‘success’ or ‘accuracy’ is defined, researchers should examine why some methods are superior to others. Is it because the information they provide can be more readily incorporated into decision making? The criterion variable ‘success’ is multi- dimensional. It includes perceived success, statistical accuracy, utility, and cost-effectiveness among other dimensions.

The implementation of a political risk forecast, according to the literature, depends a great deal on top management acceptance. In the Canadian study, this was present. Another important aspect is the need for company-specific and project- specific analyses. These occurred in the Canadian firms because most analyses were done in-house and on demand. Further investigation is required

about the existence of bias and ways to reduce bias, however. This is especially important because of the predominance of the judgmental approach to forecasting.

Finally, the Canadian study provided an opportunity for comparison with the results of American, French and Japanese research. Few cross-national differences were found. The primary one is the difference in information sources used. This is related to the relationship between government and business in a country and the nature of the banking system. It was difficult to make some comparisons because of variations in research instrument design and the different times at which the studies were conducted. Ideally, a cross-national study would be conducted investigating

several countries at the same time using the same research instrument.

Acknowledgement

We would like to thank Urs Thomas for his research assistance for the empirical work reported in this paper. The survey of Canadian firms was supported by a grant from Concordia University, Montreal and was conducted by the first author when she was a faculty member there. An earlier version of the paper was presented at the Annual Meeting of the Academy of Interna- tional Business, San Diego, October 20-22, 1988. We are grateful to Professor Stuart Bretschneider of Syracuse University and to two anonymous referees for their helpful suggestions in improving the paper.

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Biography: Gillian RICE is Associate Professor of Marketing

at the American Graduate School of International Manage-

ment (Thunderbird). She received her Ph.D. in 1982 from the

University of Bradford. Her work has appeared in journals

such Mmugement International Review, Journal of Forecastinq,

Journal of the Academy of Marketwtg Science. and Internatronal

Marketmg Review. Her current research interests include the

assessment and management of political risk, the implementa-

tion of forecasting methods and forecasting applications tn

international marketing. She is book review editor for the

Journal of Global Marketing.

Essam MAHMOUD is Professor of Management Science at the American Graduate School of International Management

(Thunderbird). In 1982. he received his Ph.D from the State

University of New York at Buffalo. He has published widely in

journals such as Journal of Forecastwg Technologtcal Forecast-

ing and Socrul Change, Information & Management, and The

Amencan Statlsttcian. His research focuses on forecasting accu-

racy. the combming of forecasting methods and software

evaluation for forecasting. He is an active member of the International Institute of Forecasters. He serves on the edi-

torial boards of Interncrtronal Journal of Forecasttng, Journcrl of

the Academ.v of Marketrng Suence. and Information & Manuge-

ment.

Political risk forecasting by Canadian firms

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