This paper explores firms’ strategic options when their investments are subject to the threat of government expropriation. I develop a simple hold-up model of political risk. In the model, a firm decides whether to invest and then the government decides whether to expropriate the firm’s investment or to simply collect normal taxes on its profits. The government is motivated by revenue and a wide range of nonpecuniary factors: its reputation, electoral pressures, patronage opportunities, and pressure from external actors. In the model, the likelihood of expropriation depends on several factors: the firm’s profits, the amount of taxes it pays, the government’s ability to operate the firm’s assets, and the government’s political incentives. Effective management of political risk requires an integrated strategy, consisting not only of public and government relations efforts, but also financial, value chain, and human resources strategies designed to reduce the government’s incentives for expropriation.
I received helpful comments from David Baron, John de Figueiredo, Sergei Guriev, Nate Jensen, Dylan Minor, two reviewers, and participants at ISNIE 2015 and the 2015 Conference on Strategy & the Business Environment. I also thank Stanford MBA and MSx students, and Executive Education program participants who have shared with me their experiences and thoughts on the topic of political risk.
Shotts, K.W. (2016), "Political Risk as a Hold-Up Problem: Implications for Integrated Strategy", Strategy Beyond Markets (Advances in Strategic Management, Vol. 34), Emerald Group Publishing Limited, Leeds, pp. 57-85. https://doi.org/10.1108/S0742-332220160000034003
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