International projects and political risk management by multinational enterprises: insights from multiple emerging markets

2.1 Political risk

Based on Knight's (1921) seminal conceptualization, risk refers to a set of possible outcomes, and the likelihood of each occurring can be calculated, while uncertainty refers to outcomes where the likelihood of each taking place is unknown. Therefore, unlike uncertainty, which is unmeasurable, random and unpredictable, the risk is, to some degree, measurable (Mullner, 2016). Yet, this approach has been challenged due to its failure to capture decision-makers' role (Hsieh et al., 2010). From the decision-makers' point of view, the risk is often perceived as associated with hazards, disappointing or negative outcomes (Deligonul, 2020; Miller and Leiblein, 1996), which significantly impacts the organization's value and its ability to achieve targets. Therefore, risk is defined here as the managerial perception of potential instabilities and vulnerabilities faced by MNEs that impose limitations, restrictions or even losses in international markets (Ahmed et al., 2002).

In the international market entry context, Meschi (2005) highlights that risk involves political and economic risks. Although the importance of economic risk in MNE's international operations is recognized in prior literature (e.g. Ahmed et al., 2002; Deligonul, 2020; Puck et al., 2009), the main interest of the current study lies in political risk. Broadly speaking, political risks emanate from the possibility of adverse effects on MNE's business due to the host country's potential events. Khattab et al. (2007) noted that prior literature concerned with political risk conceptualization is divided into two groups. One group of researchers define political risk as risk arising from political actions of the government, which include taxation restrictions, currency inconvertibility, contract repudiation, import and/or export restrictions, ownership and/or personnel restrictions, expropriation and/or confiscation (e.g. Butler and Joaquin, 1998; Deligonul, 2020). On the contrary, other groups of researchers define political risks as risks arising from governmental and societal actions, and social actions include demonstrations, riots and insurrection, revolutions, coup d'etat, civil wars and terrorism (Stosberg, 2005).

Considering that EMs have an under-developed social–political environment that can harm MNEs' operations (Casson and Lopes, 2013), managerial perception of political risk would depend on various political and societal events in the host country. Subsequently, political risk in EMs stems from potential political and social events that may cause adverse effects on an MNE's business in EMs. Factors such as political violence, regime changes, coups, revolutions, breaches of contract, terrorist attacks, wars and discriminatory actions of the host government (e.g. expropriation, unfair compensation, foreign exchange restrictions, unlawful interference, capital restrictions, corruption and labor restrictions) are among the types of political risk possibilities, especially in IPOs (Chang et al., 2018). Prior research suggests that political risk causes extra expenditures or unexpected adjustments to the project plan, direct financial losses, less overall satisfaction and hence negatively affects the continuity of an MNE's IPOs in the target country (Chang et al., 2018; Zhang and Wei, 2012). Therefore, political risk in IPOs should be handled effectively to materialize the benefits of the project (Chang et al., 2018).

2.2 International project operations and political risk identification

Historically, a project is a one-time “temporary endeavor undertaken to create a unique product or service” (PMI, 2000, p. 4). However, project-based business operations have been on the rise since the origination of modern PM in the 1960s (Turner, 2009). IPOs cover “a broad mix of activities involved in the design and construction of different plants and facilities: such as housing, office buildings, factories, industrial plants, mining development, defense establishments, and social infrastructure facilities (power utilities, transport, etc.)” (Luostarinen and Welch, 1990, p. 126). Kardes et al. (2013) report that the lack of appropriate infrastructure in EMs has increased the demand for large-scale projects, especially during the past two decades. Consequently, many DMNEs, which originally started operations as original equipment manufacturers (OEMs) of world-renowned products, have also undertaken IPOs as their growth strategy (Owusu et al., 2007; Kowalkowski et al., 2015). Among such DMNEs, Siemens, ABB, Mitsubishi, Areva, Caterpillar and General Electrical are a few prominent examples. These OEMs have undertaken highly complex mega projects (e.g. Kardes et al., 2013) and made a considerable contribution to the world's infrastructure development. This study focuses on one such MNE, which originally started as OEM, but later also started undertaking IPOs in the energy sector.

Prior research suggests that instead of viewing IPOs as a single step, it is useful to view them as a process (Welch et al., 2018). Cova and Holstius (1993) present six stages of the project process: search, preparation, bidding, negotiation, implementation and transition. Though the scholars mention that there may be variations on how the process proceeds in an individual project case, we have attempted in Table 1 to provide an overview of the stages of the project process found from the secondary sources of our case IPOs. The project process is a cycle of four stages of market development and opportunity search, project preparation and development, bidding and negotiation, and implementation. Key activities performed during each stage are also elaborated in Table 1.

The seminal work of Liesch et al. (2011) suggests that decision-makers initially face uncertainty only. As decision-makers actively gain more information, they convert some uncertainties to risk, allowing them to make decisions and take actions. This evolving view is a key step that can help to bridge the existing research on risk and uncertainty in IPOs (Mullner, 2016). Therefore, the availability of information reduces uncertainty from the decision-maker's point of view and converts it into a risk. Project literature widely acknowledges that uncertainty is highest at the initial stage of the project and diminishes and converts into risk as the project progresses due to information accumulation (Samset and Volden, 2016).

2.3 Mechanisms of political risk management

Risk management is a structured process to minimize or mitigate the likelihood of risks and their negative effects (Deligonul, 2020; Mabrouki et al., 2014). International Organization for Standardization (ISO, 2018) has identified four steps to manage business risk: identifying the potential risks, analyzing and evaluating them, choosing and implementing actions to reduce them, and monitoring the risks. Although process identifies the steps to manage and monitor the business risks, it does not specify mechanisms for managing business risks, including the political risks. Therefore, we carried out extensive literature review on the political risk management and found no precise theoretical model for managing political risk in IPOs. However, this review led us to identify three streams of literature, which can be employed to explain the mechanisms for managing political risk in IPOs: international market entry, finance and PM literatures.

In the international market entry literature, scholars have used the SET and TCT to manage the political risks. The SET is a sociological theory initially developed to analyze people's social behavior in terms of the exchange of resources (Blau, 1964). Although the origins of the SET are at the individual level, the theory has been extended to inter-firm level (e.g. Muthusamy et al., 2007; Ali and Larimo, 2016) and MNE–host government level (e.g. Luo, 2001, 2004). As described here, the logic of theory “that no actor is self-sufficient, actors will have to interface with each other to obtain needed complementary resources” has been extended to the MNE–host government level. According to the SET, MNEs and host governments need each other for critical complementary resources in today's world economy, and sharing complementary resources cooperatively creates a payoff for both (Luo, 2001, p. 402). Hence, the SET assumes a cooperative relationship between MNEs and host country governments by underscoring the potential for mutual gain (Luo, 2001, 2004). The research built on this assumption has proposed flexibility-cooperative mechanisms, such as the alignment of an MNE's objectives with the host government's social and economic objectives and developing trust-based informal networks with local businesses and people of the host government to reduce political risk (Cavusgil et al., 2013). However, the TCT assumes a conflictual–adversarial relationship between the foreign MNEs and the host government due to their different objectives and self-interest with guile (Luo, 2001, p. 402). The former focuses on wealth generation, while the latter focuses on social welfare (e.g. Luo, 2001, 2004). The research built on this assumption has proposed for control mechanisms, such as the formation of EJVs with a target country firm (Lopez-Duarte and Vidal-Suarez, 2010; Puck et al., 2009). This assumption is built on the logic that the target country firm's possession of country-specific knowledge and overall sharing of resources and risk in an EJV should reduce political risks. However, another group of TCT scholars argues that an EJV with a target country firm can expose an MNE to particular risks associated with partners' behavior (Ahmed et al., 2002). Therefore, instead of EJV formation, MNEs should negotiate an arm's length classical contract or a CJV with a target country firm to manage the political risks (Mullner, 2016). Differentiating from the international market entry literature, finance literature suggests buying PRI as another control mechanism to reduce political risk (e.g. Lessard, 1996; Voelker et al., 2008). Finally, the PM literature proposes that the choice of appropriate payment method (i.e. the choice between fixed cost, cost plus fixed fee and target price) in IPOs is an important control mechanism that mitigates the political risks. Furthermore, conventional wisdom from the PM literature suggests that at high political risk, cost plus fixed fee and target price are the best methods to manage these risks (Turner, 2001). Thus, various strands of prior literature propose a range of mechanisms to reduce political risk in IPOs ranging from different strategic options to payment methods. Given the complex and multifaceted nature of political risks in EMs, we adopt the view that several mechanisms are required to reduce them. We develop the following comprehensive conceptual framework of political risk management based on the prior literature as well as the first phase of data collection and analysis (Figure 1). After the second phase of data collection and analysis, this framework has been further upgraded (Figure 4).

3.1 Data collection and analysis

This research seeks an abductive approach to data collection and analysis by systematically combining the theory and empirical data from research cases (Dubois and Gadde, 2002). Accordingly, we did not follow a linear approach wherein a literature review-based model could lead to data collection and analysis. Rather, we adopted an inductive–deductive approach of several updates to the model, which was eventually used for thematic data analysis and the case findings presentation. In particular, we adopted a two-phased approach of data collection and analysis (Table 2).

The first phase comprises the development of the research model and data collection simultaneously, where we exchanged emails with key informants and later undertook face-to-face meetings (Yin, 2003). The logic of doing project business, sources of political risks and their used strategies for managing those risks in the project business context were learned from the key informants. Meanwhile, researchers collected secondary data from the World Wide Web about the case company and its project operations modes. Key informants also facilitated face-to-face discussions with some of the case projects' team members and helped access some of the case project-specific information (secondary data) for this research (Table 2). This first phase of collecting primary and secondary data enabled combining the theory with the empirical world (Dubois and Gadde, 2002) and developing the preliminary research framework (Figure 1).

The second phase of data collection and analysis constituted of 14 semi-structured interviews of key experts identified during the first phase of data collection. Additionally, their significant role in the decision-making related to the case projects and at the case company's management level was verified with the key informants. The interviewees were contacted via emails with the reference of key informants. Before the interview, an interview guide (protocol) was sent to each interviewee. Alongside, the researchers verified their consent to participate in this research and guaranteed case data security and anonymity of the interviewees and the case projects.

While conducting interviews, we used the earlier shared interview guide (protocol) and a list of typical questions to structure our discussion around the research question. Each respondent was asked about (1) the physical structure of the project in target EM and whether the respondent experienced the project as a single step or comprising of different steps/stages and what were those stages, (2) their experience about the importance of political risks in IPOs in the target EM, (3) at what stage of the project, the political risks were assessed and what political risk factors were observed in the target EM, (4) what stage of the project, strategies/mechanisms were chosen to manage those political risks and (5) what strategies/mechanisms their firm had employed for managing political risks and their effectiveness in reducing political risks. Respondents were also asked about the criteria, if any, their firm had used to measure the project performance and their level of satisfaction with the project performance. For further clarification of their responses, some interviewees also shared some of the project performance reports and key milestones of the case projects (secondary data). An overview of interviewees' positions, their involvement in project stages, their experience in project operations and each interview's duration and the medium is presented in Table 3.

Based on the interviews, informal discussions and case project data, the case project briefs were developed, similar to the narrative strategy (Richmond, 2002; Riessman, 2005). Herein, the purpose was not to establish causality between the perception of political risks and the management of political risks in IPOs but to explore the mechanisms which Energy Co. deployed to manage the political risks. Therefore, instead of fracturing data into codes, the researchers connected (Maxwell, 2013, p. 112) the case briefs with the literature identified themes (i.e. political risk factors and the mechanisms of political risk mitigation). This was done manually on paper for each of the cases by two researchers individually, and then the findings were cross-verified to draw final results. According to Langley (1999), contextual details in narrative analysis offers sense-making of the hidden realities, which extant research on political risk management has not employed so far.

3.2 Research context and embedded cases

This research investigates six energy infrastructure projects (EIPs) in EMs as embedded cases (Yin, 2003) of an MNE from North Europe. Multiple embedded cases from a single MNE context provided us a consistent boundary condition for interpreting the data and facilitated the findings' analytical generalization (Teagarden et al., 2018). The case company, here called Energy Co., is an OEM that operates globally through its network offices in more than 60 countries. Major manufacturing facilities of the Energy Co. are in Europe and Asia. The business focus of Energy Co. is on delivering EIPs in developed as well as in EMs. Energy Co. has positioned itself as one of the key players in the energy market with its global business focus.

Based on the guidance from Söderlund and Tell's (2009) study, Energy Co. can be considered as a P-form enterprise whose focus is on the integration of technology-based products and services from its various functional and manufacturing units (Melkonian and Picq, 2011). Hence, Energy Co. differentiates itself as a solution provider of infrastructure projects comprising of large complex product systems (Kowalkowski et al., 2015). Several of the infrastructure projects implemented by Energy Co. fulfill Kardes et al. (2013) criteria for a megaproject. Meanwhile, Energy Co. has two dedicated business divisions, one for the offshore infrastructure projects and one for the onshore infrastructure projects. All the six cases investigated in this research are onshore EIPs in EMs. Detailed contextual characteristics of these projects are outlined in Table 4.

4.1 Political risk factors

Though Energy Co. evaluates all the political risk factors identified in this paper's literature review, the relevance of political risk factors in each EM depends on the ground realities of that particular EM. Political risks in EMs that were of concern to most of the respondents, in five of the six case projects in EMs, are corruption and bribes, political regime change, risk of labor unions and protests, and social violence and strikes. Table 6 summarizes the key political risks in EMs. This stresses that these political risks are pretty common in all EMs. Further, political risks that were of concern to some respondents, in four of the six case projects in EMs, are discriminatory taxation and change in tax regulations, restriction on the number of expatriate employees, excessive demands and variations in a project from the host government over time, terrorism at site location, weakly enforced laws and regulations, and security problems and risk of a violent attack on project site. This stresses that these political risks are salient concerning few EMs. Also, some political risks were of concern to few respondents, in ≤ three of the six case projects in EMs, are delay in the approval of permits, profit remittance and exchange restrictions, import restrictions, unstable government policies impacting the project, enforced renegotiations of contract by the host government, anti-project demonstrations by public, contract repudiation and an outbreak of inter-state war. However, there was no concern of nationalism or confiscation in any of the case projects in EMs. Overall, we conclude that some political risk factors are relevant in all EMs, some in few EMs and one is not relevant in any of the investigated EMs.

4.2 Applied mitigation mechanisms

After identifying the political risks in EMs, mechanisms are employed to mitigate those political risks. The mechanisms that many respondents favored to mitigate political risks, in ≥ four of the six case projects in EMs, are aligning objectives with the host government, fixed-term payment method, developing trust-based informal networks with local business and people of the host government, progressive payments and obtaining payment guarantee from local or global financial and commercial institutes. Especially the last two mechanisms, favored by Energy Co., are new findings, which prior literature on political risk management have not addressed. Table 7 summarizes the employed mechanisms to mitigate political risks. Further, in three of the six case projects, an arm's length classical contract with a target country firm was employed to reduce political risks. In addition, mechanisms that some respondents favored to mitigate political risks, in two of the six case projects in EMs, are CJV formation with a target country firm and seeking a higher project price to cover contingencies. In addition, one of the six case projects, an EJV with a target country firm and buying PRI were employed to mitigate political risks. Overall, we conclude that political risk is subject to constraints from several mechanisms, where some mechanisms are important response mechanisms to mitigate political risks in all EMs and some mechanisms are employed for mitigating the political risks in some EMs.

4.3 Analytical framework for political risk mitigation in emerging markets

We draw two key conclusions about the applicability of political risk management mechanisms. Firstly, some political risk factors are found relevant in all EMs, some in few EMs and the risk of “nationalism and confiscation” is not found relevant in any of the investigated EMs. However, it is important to mention that Energy Co. evaluates the risk of “nationalism and confiscation” during the second stage of “project preparation and development.” Secondly, political risks are subject to constraints from several mechanisms, where some mechanisms are used in all EMs to mitigate political risks, and some are used only in a few EMs to mitigate the political risks. In the following, we propose the analytical framework of political risk management based on the case findings, and we further discuss the applied mechanisms with reference to the prior literature (Figure 4).

The study sought to explore the mechanisms used by the Energy Co. to manage the political risks in six case projects in five EMs. The proposed analytical framework (Figure 4), based on the findings of the case projects of Energy Co., suggests that two mechanisms from the SET, namely, aligning objectives with the host government and developing trust-based informal networks with local business and people of the host government, are used to reduce political risks. Further, political risks in EMs can also be reduced by three mechanisms from the TCT, namely, EJV formation with a target country firm, CJV formation with a target country firm and arm's length classical contract with a target country firm. Two mechanisms from finance-based literature, namely, buying PRI and obtaining payment guarantee from local or global financial and commercial institutes, also mitigate political risks in EMs. Finally, three mechanisms from the PM literature, namely, fixed-term payment method, seeking a higher project price to cover contingencies and progressive payments, also reduce political risks in EMs.

5.1 Political risk identification during the project life cycle

Prior research (Samset and Volden, 2016) has suggested that uncertainty is the highest at the initial stage of the project and diminishes and converts into risk as the project progresses due to information accumulation. Our study specifically demonstrates that the political uncertainty is high during the initial stage of ‘market development and opportunity search' and starts decreasing substantially at the end of this stage as more information and knowledge about the political environment of target EM becomes available, and therefore, political uncertainty is converted into political risk. Thus, political risk is identified at the commencement of the second stage of “project preparation and development” (Figure 3).

5.2 Perceived political risk factors

While the existing literature implicitly assumes that political risk is universal, more recent literature (e.g. Han et al., 2018) has challenged this conventional wisdom. Our findings complement the research by Han et al. (2018) by revealing that the nature of political risks in EMs perceived by a DMNE is not the same. We find that a DMNE evaluates all 20 political risk factors identified in this paper's literature review (Figure 1). However, only four of them are present in all investigated EMs. These include corruption and bribes, political regime change, risk of labor unions and protests, and social violence and strikes. These political risks are of major concern in all investigated EMs, considering their devastating effects on the project operations. The remaining 15 political risk factors vary between EMs depending on the ground realities of the EMs, and one political risk factor (i.e. nationalism and confiscation) is not present in any of the investigated EMs (see Table 6 for detailed results). However, the respondents confirmed that nationalism and confiscation risk are evaluated before undertaking IPOs in EMs. Combining these results, we conclude that the overall nature of political risks varies between EMs though very few political risks are common in all EMs.

5.3 Mechanisms to mitigate the political risks in emerging markets

The findings of this research reveal that political risks are subject to constraints from several mechanisms, where some mechanisms are commonly used in all EMs to mitigate political risks, and some are used only in a few EMs to mitigate the political risks. Previous studies present four different views to manage political risks. The SET logic (Cavusgil et al., 2013; Luo, 2001, 2004) suggests the alignment of an MNE's objectives with the host government's social and economic objectives and developing trust-based informal networks with local businesses and people of the host government to reduce political risks. The TCT logic (Lopez-Duarte and Vidal-Suarez, 2010; Mullner, 2016; Puck et al., 2009) suggests an appropriate entry mode (i.e. choice between an arm's length classical contract, CJV and EJV with a target country firm) to manage the political risks. Finance scholars (e.g. Lessard, 1996; Voelker et al., 2008) suggest for buying PRI to reduce political risk. Finally, the PM literature (e.g. Turner, 2001) proposes the choice of appropriate payment method (i.e. choice between fixed cost, cost plus fixed fee and target price) in IPOs to reduce the political risks. However, given the complex and multifaceted nature of political risks in EMs, we adopted the view that several mechanisms are required to manage the political risks (Figure 1). Specifically, we find that two mechanisms from the SET, namely, “aligning objectives with host government” and “developing trust-based informal networks with local business and people of host government,” one mechanism from the finance literature, namely, “obtaining payment guarantee from local or global financial and commercial institutes,” and two mechanisms from the PM literature, namely, “fixed-term payment method” and “progressive payments,” are commonly used by DMNEs to mitigate the political risks in all EMs (Table 6). The findings related to SET-proposed mechanisms are in alignment with the arguments of Cavusgil et al. (2013) and Luo (2004) that if DMNEs deliver projects that contribute to the economic and social well-off of the EMs, then governments of EMs will cooperate with DMNEs, and hence, political risks will be reduced. They also argue that EMs are mainly relationship-oriented, and therefore, developing trust-based social networks with local businesses and the host government will reduce the political risks. Therefore, this research's findings encourage the DMNEs to make a greater effort to align their objectives with EMs' governments' objectives and develop trust-based informal networks to reduce the political risks in EMs.

Further, the importance of “obtaining payment guarantee from local or global financial and commercial institutes” in reducing political risks is a new finding for IB literature. This mechanism forces the EM governments to think twice before engaging in actions or events that could harm the business of DMNEs. In the finance literature, Mullner (2016) and Sawant (2012) highlighted its importance in reducing overall risks. Our study confirms the importance of this mechanism in reducing the political risks in EMs. The findings related to the importance of “fixed term payment method” and “progressive payments” in mitigating political risks in EMs further extend the IB literature. Unlike the conventional wisdom from the PM literature that recommends using cost plus fixed fee or target price when risk is high (Turner, 2001), we find that fixed price is the preferred method by DMNEs to reduce political risks in EMs. Using fixed price ensures the suppliers seek the project, and further, its nexus with contract reduces the political risks in EMs. In addition, the importance of “progressive payments” in reducing political risks in EMs is a new finding for the IB literature. Although the PM literature (Luostarinen and Welch, 1990) differentiates between two types of payment methods (i.e. one-time payment and overtime progressive payment), these payment methods are not specifically linked to the political risk mitigation. We find that getting upfront payment secures the DMNEs during insecure political situations.

We also find that the importance of the remaining five mechanisms varies between EMs depending on the nature of political risks in each EM. Especially, we find very limited support for TCT suggestion that DMNEs should form EJVs with target country firms when political risk is high (Lopez-Duarte and Vidal-Suarez, 2010; Puck et al., 2009) because a local partner helps to mitigate the political risk. Overall, it is found that when political risks are too high in EMs, a DMNE prefers to use arms' length contracts or CJVs with target country firms instead of forming EJVs to mitigate the political risks. At the same time, existing finance literature highlights PRI's importance in mitigating political risks because it covers and compensates the losses occurring to the DMNEs investment due to government's direct and indirect actions (e.g. Lessard, 1996; Voelker et al., 2008; Zhang and Wei, 2012). However, we find that a DMNE rarely uses this mechanism due to the higher cost of PRI. Finally, we also find that DMNEs rarely seek higher project price to cover the contingencies due to this mechanism's higher cost. In addition, we develop an overarching and comprehensive analytical framework of political risk management based on the findings of the case projects that combine several strands of literature; SET and TCT from international market entry, PM literature and finance literature (Figure 4). This framework encourages DMNEs to use several mechanisms, a multi-strategy approach, to manage the complex and multifaceted nature of political risks in EMs. This upgraded analytical framework is a way to go for future empirical research on political risk management in EMs.

5.4 Practical implications

This research provides a number of practical implications. First, the presented holistic list of perceived political risks in EMs can assist managers in DMNEs in their considerations and choice of EMs to enter. Parsimonious identification of political risks is one of the most significant steps in outlining effective political risk management mechanisms. Second, a detailed illustration of the phases in the business project life cycle and the types of political risk that are likely to emerge in each phase serve as an assisting tool for the managers who make resource allocation decisions during IPOs and estimate ROIs. Third, although establishing high control over the business project in EMs has been the most preferred way to mitigate political risks, this study points to the significance of negotiation with the local project partners and building trust with them. Local partners not only assist DMNEs in political risk reduction, they also help in establishing understanding about the customers' preferences, requirements of local institutions, nuances of political influence and more importantly, gaining legitimate power from the local government. Still, such characteristics as reputation, capabilities and strength of political connection with the host country governments should be carefully considered when choosing potential project partner in the EMs.