Full transcript
0:00welcome to chapter 16 country risk
0:03analysis with all the technical things
0:06managers have to know when conducting
0:09International businesses I feel like the
0:12ability to understand other countries
0:14are the cultures and how people
0:16communicate interact and do business
0:19it's truly the game changer the thing
0:22that separates the successful ones from
0:25the rest
0:26if you ever have a chance to travel to a
0:29country far away from where home is you
0:32can see that it's like being in a
0:35different world altogether even the air
0:38feels different
0:40these differences that one country has
0:43over another how would that affect the
0:46business what do we need to know as the
0:49finance guy in a multinational company
0:52what are country risk how can we measure
0:55it how can we include that in making
0:58financial decisions
1:00that's the topic of our discussion today
1:03country risk is the potentially adverse
1:06impact of a country's environment on an
1:09mnc's cash flows an MNC conducts country
1:13risk analysis when it applies Capital
1:16budgeting to determine whether to
1:19implement a new project in a particular
1:21country or to continue conducting
1:24business in a particular country
1:27risk can be classified into political
1:30and financial risks here are some common
1:34political risk aspects that mncs can
1:37take into consideration attitude of
1:40consumers in the host country there
1:43might be a tendency of residents to
1:45purchase only locally produced Goods
1:48governments usually encourage their
1:51people to do so
1:53for some countries this nationalistic
1:55attitude is a lot stronger than some
1:58others here in the U.S we kind of have
2:01that but not a lot compared to many
2:04other countries
2:05I have some Korean friends and they
2:08truly believe that Korean products are
2:10absolutely the best in the world and
2:13that's how Korean companies like Samsung
2:16and Hyundai could really grow and
2:18develop like how they did
2:21the support from Korean consumers were
2:24very strong
2:25so mncs should be aware of this and
2:29perhaps if a country has such a strong
2:31tendency to buy local then a joint
2:34venture with a local company may be a
2:36better option than exporting the goods
2:39laws enacted by the horse government a
2:43host government enacts laws that serve
2:46the economic interests of the local
2:48companies and citizens
2:50there can be all sorts of barriers for
2:52foreign mncs including additional
2:55corporate taxes fund transfer
2:58restrictions and much more blockage of
3:01fund transfers a host government May
3:04block fund transfers which could force
3:07subsidiaries to undertake projects that
3:10are not optimal just to make use of the
3:12funds
3:13currency in convertibility some
3:16governments do not allow the home
3:18currency to be exchanged into other
3:21currencies
3:22war is obviously a risk conflicts with
3:26neighboring countries or internal
3:28turmoil can affect the safety of
3:31employees hired by an MNC subsidiary or
3:35by salespeople who try to establish
3:37export markets for the MNC
3:41inefficient bureaucracy can delay an
3:44mnc's efforts to establish a new
3:47subsidiary or expand business in a
3:50country imagine you have to stand in
3:52line at a DMV to conduct your MNC
3:56business
3:57corruption is obviously a concern
3:59because it increases the cost of
4:02conducting business or reduced Revenue
4:04corruption can occur at firm level or
4:08with firm government interactions
4:11Transparency International is a global
4:14non-governmental organization it has
4:17derived a corruption index for most
4:20countries you can access their website
4:23via the link on this screen here
4:26Financial Risk characteristics should
4:28also be considered a country's economy
4:31is an important one if a country is
4:34having a recession then we know that
4:37it's probably not a good time to conduct
4:39business there a country's economic
4:42growth is influenced by interest rates
4:45higher interest rates tend to slow
4:48growth people and firms also would save
4:51more and spend less so it reduces demand
4:54for MNC products
4:56exchange rates strong currency May
5:00reduce demand for the country's exports
5:02increased volume of imports and reduced
5:05production and national income
5:08inflation inflation can affect consumers
5:11purchasing power and their demand for
5:14mnc's goods
5:16for measuring country risk we do
5:18assessments macro assessment of country
5:21risk represents an overall risk
5:24assessment of a country and considers
5:26all variables that affect country risk
5:29except those that are firm specific
5:32microassessment of country risk involves
5:35assessment of a country as it relates to
5:38mnc's type of business
5:40macro assessment is general and
5:44applicable to all while micro assessment
5:47is specific and gives Nuance to the
5:50macro assessment
5:52after identifying all the macro and
5:55micro factors that deserve attention in
5:58the country risk assessment an MNC now
6:01needs to come up with a way to evaluate
6:03these factors and determine a country
6:06risk rating with the checklist approach
6:09ratings are assigned to various factors
6:12this approach is the most
6:14straightforward and we'll look at it
6:17more deeply in this chapter later on
6:20the Delphi technique involves a
6:22collection of independent opinions
6:24without group discussion a survey is
6:28said to separate respondents then the
6:30responses are collected and the MNC will
6:33try to find the consensus opinions what
6:36are the same things that everyone is
6:38saying about the country
6:41quantitative analysis is the use of
6:44models such as regression analysis this
6:47approach requires a large amount of data
6:50and the insights it provides are based
6:52on the past which may not be a good
6:55indication of what will happen in the
6:58future
6:59inspection visits or meetings with
7:02government officials business Executives
7:05and consumers to clarify risk if you
7:08remember the case study with the firm
7:10okra storm in Chapter 13 this is what
7:13they did when they sent managers over to
7:16the fictional country bluebellier to ask
7:19the government officials questions
7:22what we most likely see in real life is
7:25a combination of some of these
7:27techniques many mncs have no formal
7:30method and they use a combination of
7:33methods for the assessments
7:35an overall country risk rating can be
7:38derived using a checklist approach under
7:41this approach the overall rating is to
7:45be developed from separate ratings for
7:48political and Financial Risk
7:50first the political factors assigned
7:54values within some range such as from 1
7:57to 5. next these political factors are
8:01assigned weights the assigned values of
8:04the individual factors are multiplied by
8:07the respective weights and we get the
8:09weighted average political risk rating
8:12we can do the same thing with the
8:14Financial Risk rating once the political
8:18and financial ratings have been derived
8:20we assign weights to both the political
8:23and financial ratings and get their
8:26weighted average and that's how we end
8:28up with one value the country risk
8:31rating
8:32this diagram illustrates the checklist
8:35approach first the political factors are
8:38listed rated inside the weights in this
8:42case there are two factors blockage of
8:45fund transfers and bureaucracy the
8:48weights are 30 and 70 percent the
8:51weighted average is the political risk
8:53rating in the green square similar
8:56process is done to the financial factors
8:58to get the Financial Risk rating then a
9:02weight is assigned to each of these two
9:04eighty percent for political and 20 for
9:07financial and with that we get the
9:10overall country risk rating which is the
9:13blue square here let's try using some
9:16actual numbers the rating system we're
9:19using here ranges from one to five with
9:22five being the best value in one the
9:25least value
9:26ask a risk rating though one is the
9:29highest risk while 5 indicates the
9:32lowest risk it's a bit confusing so be
9:35careful with the interpretation in this
9:39table here column one has the political
9:41and financial risk factors that we
9:44previously identified in column 2 each
9:47of these factors is given a rating again
9:51one is the highest risk while 5
9:54indicates the lowest risk in column 3
9:57the weight for each factor is assigned
10:00based on the relative importance
10:03in column 4 we multiply the ratings by
10:06the respective weights then summed up
10:09based on whether they are political or
10:12financial factors we get the two values
10:163.3 for political and 3.9 for financial
10:20factors
10:21with those two ratings that we just
10:25determined we put them in column two of
10:28this new table for each category then
10:31the weights for the categories are also
10:34assigned these weights are different
10:37from the weights from the previous steps
10:39the weights from before are for
10:41individual risk factors and we reuse
10:45them to calculate the risk ratings for
10:47the two categories political and
10:49financial the weights being aside now
10:52are for the categories themselves so
10:55here we assigned 80 for political risk
10:58and 20 for Financial Risk make sure that
11:02they add up to 100 otherwise it won't be
11:05correct
11:06in column 4 we multiply the ratings by
11:09the weight and then add them up in the
11:12end we get 3.42 and this is the overall
11:16country risk rating for the project and
11:19here is a pro tip we can get most
11:22countries risk from this website right
11:24here go to economic research select
11:28country risk and we can access this
11:31information
11:32here you can get a country risk map like
11:35this green is low risk and red is high
11:38risk light green and light red are
11:41somewhere in between and that's pretty
11:43nice to look at too
11:45you will also find the actual ratings
11:47for each country both short term and
11:50medium term isn't that amazing
11:53with the country risk analysis conducted
11:56mncs receive new insights about the
11:59feasibility of the projects they can
12:02incorporate these new information in
12:04their Capital budgeting analysis there
12:07are typically two methods of doing that
12:09first is adjustment of the discount rate
12:13lower risk rating implies higher risk
12:16and higher discount rate so now the MNC
12:20may want to apply a higher discount rate
12:22than before to reflect this risk another
12:26method is adjustment of the estimated
12:28cash flows a chairs estimates for the
12:32probability that cash flows may not be
12:34realized this will lower the remitted
12:37cash flow each year and ultimately
12:39affect the net present value of the
12:42project let's revisit our case study of
12:45Spartan Incorporated from chapter 14.
12:48this table here shows what we got in
12:51that example with the country risk
12:53analysis conducted we now have
12:56additional information there is the
12:59probability of a 20 withholding tax
13:01instead of 10 like before and this
13:04probability is 30 percent
13:07also there is a 40 chance that the
13:10salvage value will be less than what we
13:12expected
13:14how can we incorporate this information
13:16in our Capital budgeting analysis
13:19let's see what would happen if there is
13:22a 20 withholding tax
13:24step 15 would be affected and the
13:27amounts are now twice as large as before
13:30with the 10 withholding tax this would
13:33also change step 16 step 19 and the rest
13:37ultimately the npv for the project is
13:41one million two hundred fifty two
13:44thousand and 160 dollars next we look at
13:49the scenario when the withholding tax
13:52stays at 10 percent but the salvage
13:54value is now only 7 million Singapore
13:58dollars that would really affect the
14:01cash flow for year four and in turn the
14:04npv of the project which is now only 800
14:09484 dollars finally we look at the worst
14:13case scenario where everything goes
14:16wrong
14:16we are really pulling a Murphy's Law
14:19here this time we get both the 20
14:22withholding tax rate and the lower
14:24salvage value everything is changed from
14:27steps 15 down the project is now a
14:31negative 177
14:34223 dollars after looking at all four
14:38scenarios we can come up with a table
14:40like this one in one column we list out
14:44the npv for each scenario that's the
14:48second column from the right
14:50then we have another column for the
14:52probability of each scenario how do we
14:55do this well we know the probability for
14:58the twenty percent withholding tax of 30
15:01percent so the probability of the ten
15:04percent is 70 percent similarly the
15:08probability of the lower salvage value
15:11is 40 percent so the probability of the
15:14higher salvage value is 60 percent
15:17for scenario one we have the ten percent
15:21tax rate and the High salvage value so
15:24the probability for this scenario is 70
15:28percent times sixty percent and we get
15:3042 percent for scenario two is eighteen
15:35percent for scenarios three and four is
15:38twenty eight percent and twelve percent
15:40respectively
15:41to double check we can add the
15:43probabilities up to see if they add up
15:46to 100 so 42 plus 18 plus 28 plus 12 is
15:53indeed 100 percent
15:55so we are correct next we calculate the
15:58expected Net Present Value by multiply
16:01each scenarios npv by its probability
16:04then add them up
16:06we get one million three hundred sixty
16:09four thousand eight hundred and one
16:11dollars for the npv of the project it's
16:15still positive so that's not bad at all
16:18and MNC should not only consider country
16:22risk when assessing a new project but
16:25should also reveal the country risk
16:27periodically after a project has been
16:30implemented it should be an ongoing
16:32process
16:33if an MNC has a subsidiary in a country
16:37that experiences adverse political
16:39conditions it may need to reassess the
16:43feasibility of maintaining this
16:45subsidiary
16:47the worst thing that can happen is not
16:50the high withholding tax or low salvage
16:53value the worst thing that can happen is
16:56that the host government will just take
16:59over the subsidiary if that happens
17:02there really is nothing the MNC can do
17:06at all
17:07so we obviously do not want that there
17:10are a number of strategies to reduce and
17:13mnc's exposure to a host government
17:15takeover One is using a short-term
17:19Horizon with this strategy the MNC
17:22focuses on recovering cash flows quickly
17:25and get out of there before something
17:27funny can happen
17:29another idea is to rely on unique
17:32supplies or technology the idea is to
17:35make sure that if the Takeover ever
17:38happens the production will be rendered
17:40useless either by cutting off the
17:43supplies or making the Necessary
17:45Technology unavailable
17:48hiring local labor is another thing mncs
17:51can try but it's not a very effective
17:54strategy because the host government can
17:57just retain the employees after the
17:59Takeover
18:00borrowing local funds is another idea an
18:04MNC can Finance the project with local
18:07banks so that if the Takeover happens
18:10these Banks won't get the money back the
18:14local banks would not want that to
18:16happen so they would try to pressure the
18:19government to not take over
18:21this strategy is also not very effective
18:24because the government can just reassure
18:27the banks that they will be repaid no
18:29problem another way is to purchase
18:32insurance to cover the risk of
18:34expropriation
18:36the World Bank has established the
18:39multilateral investment guarantee agency
18:41or Miga to provide political insurance
18:45for mncs with direct foreign investments
18:48in less developed countries
18:51another strategy is to use what's called
18:54a project Finance deals
18:57in a project Finance deal the project is
19:01financed mostly with credit the credit
19:04is backed by the Project's future
19:06revenues from production in this case
19:09creditors are only entitled to the
19:11assets and the cash flows so this kind
19:14of deals is called non-recourse
19:17using project Finance deals doesn't
19:19expose the mncs to a lot of risk because
19:22of these characteristics a government is
19:26also less likely to try to take over
19:28such projects because it would have to
19:31assume the existing liabilities due to
19:33the credit Arrangement so this can be an
19:36effective way and this concludes our
19:39discussion of chapter 16. I hope you
19:42found it interesting I enjoyed it
19:45take care and have a wonderful day