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Article

How companies can offset the risks of foreign investments

Strategy

Investing abroad can be a risky business for firms, so many only invest in countries that can safeguard investments through treaties. But some companies do invest in less stable countries without the protection of bilateral treaties. Pierre Dussauge, HEC Professor of Strategy and Business Policy explains how these firms instead use their political influence to get ahead of competitors.

money globe ©Hyejin Kang-AdobeStock

Foreign direct investment is a cornerstone of growth for large companies. This is never without risk though. For instance, corporations think twice before putting their money in, say, Zimbabwe, where (now ex-)President Mugabe was prone to grabbing foreign assets, or suddenly deciding investments from abroad should be controlled by 'indigenous Zimbabweans'. To prevent their property from ending up in the hands of local strongmen, most companies tend to venture in countries that guarantee the long-term safety of investments. However, other firms make seemingly risky investments in countries where there are no official safeguards in place. These are often economically and politically unstable countries, with high levels of corruption.

Our latest study uncovers the reasons why some companies only invest under the protection of supranational arrangements whereas other companies choose to operate in countries where their investments seem to be at far higher risk.

Until now, it has not been clear why some companies play it safe with their foreign investments while others are willing to swim with sharks. Our latest study uncovers the reasons why some companies only invest under the protection of supranational arrangements whereas other companies choose to operate in countries where their investments seem to be at far higher risk. 

Overseas investments: a big risk

When a company invests overseas it is at the mercy of the foreign governments. Change in the political landscape of a country - through democratic vote or revolution – can jeopardize foreign investments. On one end of the scale this can lead to high taxation of foreign investors, and on the other, expropriation of assets. For example, the Cuban revolution in the 1950’s saw American assets seized and today, companies are still hoping for compensation. In either case, we see companies regretting their decision to invest in the country. This means that, where there is uncertainty and risk of political change, most companies shy away from investing. 

Bilateral Investment Treaties increase foreign investment

When investing in a foreign country, most companies require an official safety net for their investments. These trusted safeguards often come in the form of Bilateral Investment Treaties (BITs) which are long-term agreements between countries that guarantee investments even if the political landscape is turned on its head.

If a country doesn’t abide by the terms of the BIT, the dispute is handled by a third adjudicating country. According to UNCTAD data, by 2017, most countries in the world had signed more than 3,000 BITs and international arbitration institutions had resolved more than 500 dispute cases involving such BITs.

Our study has shown that when two countries set up a Bilateral Investment Treaties, this will directly lead to more investments between the two countries.

BITs play an important role in driving foreign investments as it has always been clear that there are more investments between countries with BITs. However, it was never clear which came first, the investments, or the BITs? By looking at the individual decisions made by countries and investing firms, for the first time, our study has shown that when two countries set up a BIT, this will directly lead to more investments between the two countries. 

conflict world map ©kirill_makarov-AdobeStock
Through political competence and political connections, firms are able to invest in these countries, where they face less competition (Photo Credit ©kirill_makarov on AdobeStock)

Politically connected companies are able to invest in unstable countries that other firms shy away from

Despite the presence of BITs, some companies actively choose to invest in countries where their investments are not safeguarded by such BITs. These countries are generally economically and politically unstable, having weak institutional environments – i.e. they are plagued by corruption or suffer from weak rule of law – as classified by existing World Bank rankings.

Our study has revealed why these companies choose to take their chances. What they do is rely on various forms of political influence to make investments in risky countries their more traditional competitors are reluctant to enter. They don’t seem to fear uncertainty and risk of political change in the same way as those firms that lack political influence and therefore have little choice but to rely on BITs. 

Companies rely on strategies of political influence such as lobbying and other forms of political engagement (…) very legal non-market strategies.

By getting involved in the politics of these unstable countries, companies can make their seemingly precarious investments safer. Our study shows that these companies have at least one of two ‘non-market capabilities’ that enable them to influence decisions. 

1- Political competence - This is a skill that companies develop over a long period of time while operating in unstable countries and countries with weak institutions.

2- Political connections - These are relationships that companies build for example by hiring ex-politicians to be members of the board or managing team.

In both cases, companies rely on strategies of political influence such as lobbying and other forms of political engagement. 

Political influence: Non-market strategies are not all bad 

So is “non-market capabilities” just a byword for shady dealings? Facilitating corruption is indeed unethical, however lobbying and other forms of political engagement are very legal non-market strategies that can be exploited. Companies that possess these non-market capabilities are freer to operate in an environment with less competition.

As such, it is important to understand how these capabilities are used and with which results. For example, our investigation revealed that some French firms with communist connections made many profitable investments in Cuba. There was little competition as the Cuban market remained closed to firms without these connections.

There was little competition as the Cuban market remained closed to firms without these connections. 

In addition, foreign companies making investments in these countries can aid economic growth and foster innovation. A country may be weak institutionally and suffering from political unrest, and in the absence of BITs, foreign investments made with the help of political influence, can offer a lifeline.

Foreign companies making investments in these countries can aid economic growth and foster innovation.

 

Methodology

Focus - Methodologie
Our study focused on 3,669 direct international manufacturing investments undertaken by 793 listed companies from 11 home countries in 113 host countries between 2003 and 2006. We assessed if BITs affected the location of investment (controlling for other factors commonly found to influence foreign investment location choice).

Applications

Focus - Application pour les marques
Not taking a moral stand, if a firm intends to do business in less institutionally stable countries, non-market capabilities matter and can substitute for BITs in helping firms with such capabilities mitigate risks. Through political competence and political connections, firms are able to invest in these countries, where they face less competition. If a company does not have the skill of political competence gained by experience, then they will need to get someone on board with a political background and the ability to politically influence countries that the company wants to invest in. From a macroeconomic point of view, as most firms don’t possess these non-market capabilities, to attract foreign investment, countries need to sign more BITs. If an institutionally weak country does not have many BITs in place but wants foreign investment, they should target firms that have experience investing in similar countries.
Based on an interview with Pierre Dussauge and on his article “Firm Non-Market Capabilities and the Effect of Supranational Institutional Safeguards on the Location Choice of International Investments”, co-written with João Albino Pimentel (former PhD student at HEC Paris, now Assistant Professor at Darla Moore School of Business) and J. Myles Shaver (University of Minnesota Twin Cities), Strategic Management Journal 39.10 (2018): 2770-2793.

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