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The Management of Political Risk

21 Pages Posted: 29 Jun 2016 Last revised: 12 Jul 2016

Erasmo Giambona

Syracuse University - Whitman School of Management - Finance Department; James D. Kuhn Center for Real Estate

John R. Graham

Duke University; National Bureau of Economic Research (NBER)

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Date Written: July 12, 2016

Abstract

We explore a long standing prediction in the international business literature that managers’ subjective perceptions of political risk – not just the level of risk – are important for how firms manage political risk. The importance attributed to political risk by corporate executives has increased over the last 15 years and our results show that political risk is now considered more important than commodity (input) risk. Our analysis suggests that nearly 50% of firms avoid (not simply reduce) foreign direct investment because of political risk. Using a unique survey-based psychometric evaluation of manager risk aversion, we show that firms with risk averse executives are more likely to avoid investment in politically risky countries – a key implication of behavioral models. This relation is economically stronger when agency problems are more likely to be severe: for example, when executives are less aligned with shareholder value maximization, and when executives are younger (and therefore might put their personal career’ concerns in front of shareholders’ interests). While numerous studies have shown that political risk affects foreign direct investment using objective measures of such risk (electoral uncertainty, conflicts, etc.), our study documents that executives’ subjective perceptions of political risk are also important for political risk management.

Keywords: Political risk, Risk management, Hedging, Real options, Cost of capital, Derivatives, Investment, Foreign direct investment, Risk aversion, Behavioral theory, Agency theory, Economic growth, FDI, ISDA, GARP

JEL Classification: G18, G28, G31, G32, G38

Suggested Citation

Giambona, Erasmo and Graham, John R. and Harvey, Campbell R., The Management of Political Risk (July 12, 2016). Duke I&E Research Paper No. 2016-32. Available at SSRN: https://ssrn.com/abstract=2801334 or http://dx.doi.org/10.2139/ssrn.2801334

Erasmo Giambona

Syracuse University - Whitman School of Management - Finance Department; James D. Kuhn Center for Real Estate ( email )

721 University Avenue
RM 120-D
Syracuse, NY 13244-2450
United States
315 443-4885 (Phone)

John Robert Graham

Duke University ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7857 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

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