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WP 2002-06 A Working Paper of the

1 Although insurers often treat political risk as a country-specific phenomenon, substantial variation in the probability and magnitude of loss exists at the firm level. Individual firms confront different sources of policy uncertainty and political influence depending on factors such as their size, nationality, familiarity with the local environment, partner status, technological leadership and network of global stakeholders. Sophisticated managers address political risk by employing tailored risk mitigation strategies that reflect the specific factors affecting a firm's risk profile. Insurers may therefore determine the proper scope and price more accurately and efficiently by assessing the fitness of a given political risk mitigation strategy. In this paper we provide a simple framework that can be used to make such an assessment. The framework revolves around a firm's bilateral " bargain " —its implicit or explicit agreement about what portion of its returns it will appropriate—with a host country government. Over time, the government is likely to face electoral, financial or economic incentives to increase the fraction of the firm's returns that get redistributed to competitors, suppliers, buyers or the broader polity. We develop our framework by first identifying the factors that imbue a foreign firm with " bargaining power " that it may exploit to protect its initial bargain. We next consider how a firm's industry position affect the optimal form of the arguments that its managers make in attempting to influence the policymaking process. Finally, we discuss the dynamic integrity of a firm's political risk mitigation strategy, i.e., the extent to which the strategy balances short-term profitability with resistance to the future political backlash that could result from the appearance of privilege or inequity. The choices that management makes in all three of these areas affect the probability and likely magnitude of a firm's loss from adverse government behavior. 2 We draw from extensive field interviews in the electricity generation and cellular service industries of thirteen emerging markets in East Asia, South America and Central Europe to support our arguments. 1 Managers at all of the firms that we visited stressed the importance of their government and public relations functions in reduc ing the probability and severity of attempts by public officials—acting in the interest of consumers, competitors, suppliers, potential entrants or other interested parties—to squeeze profits out of the firm. Such attempts typically took the form of policy decisions that altered the terms of existing contracts, the structure of …