Political risk and the internationalization of firms: An empirical study of Canadian‐based export and FDI firms

• Published date: 01 September 2007
• Date: 01 September 2007
• Author: Dorothee Feils,James Agarwal
• DOI: http://doi.org/10.1002/cjas.26

Can J Adm Sci

Copyright © 2007 ASAC. Published by John Wiley & Sons, Ltd. 165 24(3), 165–181

Political Risk and the Internationalization

of Firms: An Empirical Study of

Canadian-based Export and FDI Firms

James Agarwal

University of Calgary

Dorothee Feils*

University of Alberta

Canadian Journal of Administrative Sciences

Revue canadienne des sciences de l’administration

24: 165–181 (2007)

Published online 29 August 2007 in Wiley Interscience (www.interscience.wiley.com). DOI: 10.1002/CJAS.26

*Please address correspondence to: Dorothee Feils, School of Business,

University of Alberta, Edmonton, Alberta, T6G 2R6, Canada. Email:

dorothee.feils@ualberta.ca

Abstract

Political risk analysis primarily receives attention for

foreign direct investment (FDI) but only rarely for

exporting. We examine how exporters and foreign direct

investors evaluate the relative importance of political

risk factors. We provide a rationale for exporters to

evaluate political risk factors for FDI and for foreign

direct investors to evaluate political risk factors for

exporting. Survey data were collected from Canadian

exporters and foreign direct investors and capture the

distinctive nature of salient factors for exporting and

FDI. We offer unique insights on the evolutionary char-

acter of political risk that are of practical value for both

exporting and FDI. Copyright © 2007 ASAC. Published

by John Wiley & Sons, Ltd.

JEL Classif‌i cation: F23

Keywords: exporting, FDI, internationalization process

of f‌i rms, political risk assessment, political risk factors

Résumé

L’analyse du risque politique a été essentiellement

étudiée en rapport avec les investissements étrangers

directs (IED) et rarement en rapport avec l’exportation.

La présente examine la manière dont les exportateurs

et les investisseurs étrangers directs déterminent

l’importance relative des facteurs de risque politique.

Elle présente aussi les raisons qui doivent pousser les

exportateurs à évaluer les facteurs de risque politique

liés aux IED et les investisseurs étrangers directs à

évaluer les facteurs de risque politique liés à l’exportation.

Les données utilisées ont été collectées auprès des expor-

tateurs et des investisseurs étrangers directs canadiens.

L’étude jette une nouvelle lumière sur le caractère

dynamique du risque politique et est d’un intérêt pra-

tique pour les exportateurs et les investisseurs directs

étrangers. Copyright © 2007 ASAC. Published by John

Wiley & Sons, Ltd.

Mots-clés : exportation; IED; processus

d’internationalisation des entreprises; évaluation du

risque politique; facteurs de risque politique

Formal political risk analysis has received attention

only since the 1960s when U.S. multinational enterprises

experienced signif‌i cant losses due to expropriations

(Overholt, 1982). Consequently, conceptual studies on

political risk def‌i nitions focus on foreign direct invest-

ments (FDI) ignoring other forms of international

involvement such as exporting, outsourcing, licensing,

and franchising (de la Torre & Neckar, 1988; Kobrin,

1979; Monti-Belkaoui & Riahi-Belkaoui, 1998; Robock,

1971). Even though practitioners consider political risk

POLITICAL RISK AND THE INTERNATIONALIZATION OF FIRMS AGARWAL & FEILS

Can J Adm Sci

Copyright © 2007 ASAC. Published by John Wiley & Sons, Ltd. 166 24(3), 165–181

to be important for other international activities (Minor,

2003; Price, 2005; Short, 2005), empirical studies take

the same approach (Kobrin, Basek, & LaPalombara,

1980; Pahud de Mortanges & Allers, 1996; Rice &

Mahmoud, 1990) with only a few exceptions such as

Coplin and O’Leary (1982).1

Since political risk can take many different forms,

different facets of political risk need to be assessed

depending on the type of a f‌i rm’s international involve-

ment and the f‌i rm’s stage of internationalization. Politi-

cal risk is a highly relevant factor during the preentry,

entry, and postentry stages of the “process” model of

internationalization (Yip, Biscarri, & Monti, 2000). For

example, strategic planning, market research, and market

selection all consider motivations such as market poten-

tial and risk assessment as part of the preentry process;

while planning for contingencies and postentry strategic

commitment both look at strategic modality shifts from

export to contractual agreement or FDI, and vice

versa, as part of the postentry process. Focusing on less

important facets of political risk may lead to poor

decisions.

It is generally assumed that less capital is at stake

for exporting and therefore political risk is of lesser

importance to exporters (Stapenhurst, 1992). However,

the loss of expected future revenues often signif‌i cantly

exceeds the value of the expropriated assets (Gillespie,

1989). While exporters may not lose any facilities, they

face nonpayments on goods already shipped and loss of

expected future sales. Exporters may also be subject to

increasing political risk over time due to the emergence

of the World Trade Organization, which obligates

member countries to signif‌i cantly reduce tariff barriers.

While tariff barriers have gone down, many nontariff

barriers have been increased. Also, outright expropria-

tions are less common today than they were four decades

ago (Minor, 2003). Firms are now more concerned about

other aspects of political risk such as exchange controls,

changes in taxation, political and social unrest, and con-

tract repudiation (Hashmi & Guvenli, 1992; Molano,

2001; Pahud de Mortanges & Allers, 1996; Rice &

Mahmoud, 1990).

Political Risk and the Internationalization Process

There is no generally accepted def‌i nition of political

risk2 since there is a lack of agreement on its conceptual

and operational domain (de la Torre & Neckar, 1988;

Fitzpatrick, 1983; Howell, 2001; Kobrin, 1979; Monti-

Belkaoui & Riahi-Belkaoui, 1998; Sethi & Luther, 1986;

Simon, 1982). Kobrin distinguishes between two clusters

of political risk def‌i nitions: those that def‌i ne political risk

in terms of government interference with business opera-

tions and those that def‌i ne political risk in terms of

events, such as creeping expropriation, devaluation and

revaluation, foreign exchange controls, and foreign wars

(Monti-Belkaoui & Riahi-Belkaoui). Simon views politi-

cal risk as “governmental or societal actions and policies,

originating either within or outside the host country, and

negatively affecting either a select group of, or the major-

ity of, foreign business operations and investments”

(p. 68). Howell dichotomizes political risk def‌i nitions in

terms of those that require acts of national governments

and those that include political acts not originated by

governments, such as rebellions. He emphasizes that

more recently the relevant government level may not be

the national government but often the regional, state,

provincial, or local government.

It is apparent that most political risk def‌i nitions

focus on the possibility of losses rather than creation of

new opportunities and that prior work only considered

FDI since much of international business (IB) research

concerns the spread of the multinational enterprise

(MNE) (Alon & Martin, 1998; de la Torre & Neckar,

1988; Howell, 1998; Kobrin, 1979; Robock, 1971;

Simon, 1982). While IB research primarily examines

MNE behaviour, it has unfortunately not given adequate

attention to export behaviour of f‌i rms. Given that inter-

national trade and marketing is a subset of international

business and that many MNEs are also exporters, it is

within the legitimate domain of IB research to study

MNE as well as export f‌i rm behaviour. Therefore, we

need a political risk def‌i nition that encompasses the

various types of international business activities such as

exporting and FDI. In order to capture all relevant facets

of political risk as well as account for the various

types of international business activities, we use the fol-

lowing def‌i nition of political risk – a generalization of

the def‌i nition provided by de la Torre and Neckar

(p. 224)

the probability distribution that an actual or opportu-

nity loss will occur due to the exposure of . . . [f‌i rms

involved in international business activities] to a set

of contingencies that range from the total seizure of

corporate assets without compensation to the unpro-

voked interference of external agents, with or without

governmental sanction, with the normal operations

and performance expected from the . . . [f‌i rm].

Adapting de la Torre and Neckar’s (1988) def‌i nition

of political risk makes the def‌i nition comprehensive in

nature and allows for the inclusion of both actual and

opportunity loss, FDI and exporting, and governmental

and external actions. This def‌i nition includes both actual

loss (e.g., conf‌i scation) and opportunity loss resulting in