Objectives

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Objectives


•To identify the common factors used by MNCs to measure a country’s political risk;


•To identify the common factors used by MNCs to measure a country’s financial risk;


•To explain the techniques used to measure country risk;


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•To explain the roles of “local color” and “local reality” in international business relations; and


•To explain how the assessment of country risk is used by MNCs when making financial decisions.


Why Country Risk Analysis Is Important


Country risk represents the potentially adverse impact of a country’s environment on the MNC’s cash flows.


Country risk can be used


q to monitor countries where the MNC is presently doing business;


q as a screening device to avoid conducting business in countries with excessive risk; and


q to improve the analysis used in making long-term investment or financing decisions.


Political Risk Factors


q Attitude of Consumers in the Host Country.


Some consumers may be very loyal to local products.


q Attitude of Host Government


The host government may impose special requirements, restrictions, or additional taxes, subsidize local firms, or fail to enforce copyright and patent laws.


q Blockage of Fund Transfers


q “Slow” bureaucracy may be looking for bribes or ownership


q Funds may not seem to be optimally used “Bribe the Prince” may indeed be optimal.


q Currency Inconvertibility


q The MNC parent may need to exchange earnings for goods produced by the country.


q War (Impolite to mention this…). Internal and external battles, or even the threat of war, can have a devastating effect.


q Bureaucracy. Bureaucracy can complicate business.


q Corruption. Corruption can increase the cost of conducting business or reduce revenue.


Financial Risk Factors


q One financial factor is the current and potential state of the country’s economy.


q A recession can severely reduce demand, may engender new and hurtful policies.


q Financial distress can also encourage the government to restrict the MNC’s operations.


q A country’s economy is dependent on other financial factors, such as interest rates, exchange rates, and inflation.


q Government purchasing power indicators, such as the budget deficit, are also important if the government is a customer of the MNC.


q Remember, they are all good guys at the beginning. Talk to reps of other companies from your and similar homelands about the local financial and political situation. When you have invested, your fixed investment is hostage.


Types of Country Risk Assessment


q A macro-assessment of country risk is an overall risk assessment of a country without consideration of the MNC’s business.


q A micro-assessment of country risk is the risk assessment of a country as related to the MNC’s type of business.


q The overall assessment of country risk thus consists of


1. Macro-political risk


. Macro-financial risk


. Micro-political risk


4. Micro-financial risk


Risk assessors often differ in opinion due to subjectivities in


q identifying the relevant political and financial factors,


q determining the relative importance of each factor, and


q predicting the values of the factors.


Risk assessors may be reluctant to be explicit about some risks political, health, corruption.


Techniques to Assess Country Risk


q A checklist approach involves measuring all the identified factors and assigning weights to them.


q The Delphi technique involves collecting independent opinions on country risk.


q Quantitative analysis tools like discriminant analysis and regression analysis can be used when financial and political variables have been measured for a period of time.


q See what the professionals say the advice may be good even if the stated reasons are vague.


q Inspection visits involve traveling to a country and meeting with government officials, firm executives, and/or consumers.


q See if your pockets get picked when you appear drunk…


q It will usually be most appropriate to use a combination of two or more techniques.


q Comparing Risk Ratings Among Countries The Foreign Investment Risk Matrix (FIRM). Maybe the author is selling something…


Quantifying Country Risk


q 1. Assign values and weights to the political risk factors.


q . Multiply the factor values with their respective weights, and sum up to give the political risk rating.


q . Derive the financial risk rating similarly.


q 4. Assign weights to the political and financial ratings according to their perceived importance.


q 5. Multiply the ratings with their respective weights, and sum up to give the overall country risk rating.


q Note Others may do this better than you can.


q Most countries have offices to assist their nationals in setting up businesses. Get their input early and often.


Incorporating Country Risk in Capital Budgeting


q Adjustment of the Discount Rate


q The higher the perceived risk, the higher the discount rate applied to the project’s cash flows.


q Adjustment of the Estimated Cash Flows


q By analyzing each possible impact, the MNC can determine the probability distribution of the net present values for the project. Great idea. But you have to stop somewhere.


Applications of Country Risk Analysis


q While the overall risk rating of a country can be useful, it cannot always detect upcoming crises.


q The Persian Gulf crisis is an example of how a country’s risk can change over time.


q Through the 17/8 Asian crisis, MNCs realized that they had underestimated the potential financial problems that could occur in the high-growth Asian countries.


q Reducing Exposure


to Host Government Takeovers


q Use a Short-Term Payback Horizon


q This technique concentrates on recovering cash flow quickly.


q Rely on Proprietary Supplies or Technology


q In this way, the host government will not be able to take over and operate the subsidiary successfully.


q Bribe the Prince


q Hire Local Labor


q The local employees can apply pressure on their government.


q Reducing Exposure


to Host Government Takeovers


q Borrow Local Funds


q The local banks can apply pressure on their government.


q Purchase Insurance


q Many home countries of MNCs have investment guarantee programs that insure to some extent the risks of expropriation, wars, or currency blockage.


q Similar programs may be offered by the host country or an international agency too.


q


q Chapter Review


q Why Country Risk Analysis Is Important


q Political Risk Factors


q Financial Risk Factors


q Types of Country Risk Assessment


q Macro-Assessment of Country Risk


q Micro-Assessment of Country Risk


q Chapter Review


q Techniques to Assess Country Risk


q Checklist Approach


q Delphi Technique


q Quantitative Analysis


q Inspection Visits


q Combination of Techniques Always


q Comparing Risk Ratings Among Countries


q Quantifying Country Risk


q Chapter Review


q Incorporating Country Risk in Capital Budgeting


q Adjustment of the Discount Rate


q Adjustment of the Estimated Cash Flows


q Applications of Country Risk Analysis


q Reducing Exposure to Host Government Takeovers


q Impact of Country Risk on an MNC’s Value





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