Country Risk and Company Exposure: Theory and Practice

Abstract

The growth of financial markets in Asia and Latin America and the allure of globalization has made the analysis and assessment of country risk a critical component of valuation in recent years. In this paper, we consider two issues. The first is the whether country risk should be considered explicitly in valuation, and if the answer is yes, how to do it. Generically, there are two ways of incorporating country risk; we can either adjust the cash flows or change the discount rate and we will consider both approaches. The second and equally important issue is how to assess a company's exposure to country risk and we will emphasize two points. The first is that not all companies in an emerging market are equally exposed to country risk and that we need to differentiate between firms. The second is that a company's exposure to country risk comes not from where it incorporates and trades but from where it does its business. In other words, assessing and dealing with country risk can be important even for companies that trade in developed markets, if they get a significant portion of their revenues in emerging markets.

JEL Classification: F23