An Overview of Confiscation, Expropriation and Domestication

Subject: Business
Type: Expository Essay
Pages: 8
Word count: 2229
Topics: Finance, Foreign Policy, Government, Investment
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Global businesses are faced with many risks, and political risks have the greatest impact. They are external and beyond companies’ control. Political risks can transfer the control of the company without even compensating it adequately (Combes-Thuélin, Henneron & Touron, 2006). For example, the US properties were confiscated when Fidel Castro took up leadership in Cuba (Albertus & Menaldo, 2012).

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The risk of expropriation is less severe, e.g., the expropriation of the CEMEX operations of Mexico in 2008. During the regime of Chavez, the assets were seized and a negotiated price was paid to the government of Mexico. The risk of domestication uses decrees and tries to increase the influence of a host country in a foreign company. The process of domestication displayed inefficiency and non-competitiveness and have also proven to be technologically weak in the global markets (Hajzler, 2012). This essay will focus on countries that have attempted to profit from these risks by putting them to use.

Concise Summary of the Findings

Amongst the many risks which are involved in carrying on a global business, political risks are the most difficult to predict and control because they are capable of transferring the ownership of the company without compensating it adequately. Political risks pose threats on businesses that are not results of normal functioning of the economy (Dunning, 2005). They are the results of discriminatory actions which are performed by the government of the host country (Busse & Hefeker, 2007). Companies incur losses if they do not get themselves prepared for such political risks. These risks exist all over the world but vary in magnitude. The political philosophy in any country might change when there arises situations like pressurizing the government by civil groups, emergence of an opposition party as the powerful party and unstable economic conditions. (Chan, Isobe & Makino, 2008). Legitimate actions of the government like price control, output, currency and remittances can also cause such activities. Activities which are not under government control, like war, labor strikes, terrorism and extortion, can be a political threat to businesses (Levi, 2010). Political risks affect the main aspects of international businesses which include imports and exports.

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There are external factors which affect businesses adversely, and the political environment is one of them posing severe threat. Regulatory changes are potential of promoting competition in the market (Mark & Nwaiwu, 2015). Political mismanagement is capable of turning any event into devastating situations. Political environments are external to management control of the organizations and aligning them with their objectives becomes very difficult. Since these issues are very complex, corporations often do not succeed to address these issues systematically. Multinational companies are struggling with these issues and even the most experienced find it difficult to cope with it.

For most multinational companies, political risks involve unpredictable or new political decisions which further have unfavorable effects on the profits or goals of the company. Unfavorable political actions can either be detrimental such as huge destruction resulting from revolution, or can be financial such as laws, which do not allow capital movement (Al Khattab, Anchor, & Davies, 2007). There are broadly two kinds of political risks namely macro and micro risks. According to Al Khattab, Anchor and Davies (2007) macro risks such as, expropriation affect all foreign firms. Micro risks affect certain industries through corruption and actions of prejudice against foreign companies. Companies usually lose a lot of money if they are not prepared for such situations regardless of whether they face macro or micro risks. For example, hundreds of dollars which belonged to the US assets companies were expropriated after the government of Fidel Castro came to power in Cuba in 1959 (Spadoni & Sagebien, 2013). Most of these American companies also did not get their money back.

The political environment, constituting political risks, measures the likelihood of political events impacting businesses directly (Hahn, Doh, & Bunyaratavej, 2009). Political risks reduce investment desirability by lowering its expected returns. It also arise from non-governmental factors like wars, coup d’état, strikes, kidnappings, revolution, terrorism and extortion (Mark & Nwaiwu, 2015). All these actions are result of an unstable social situation that leads to frustration and intolerance among the population. These risks lead to the generation of violence, which is directed towards the properties of the firm and its employees. There are also financial constraints which are externally induced and limits are imposed externally on imports and exports.

Few laws constituted by the government results in political risks which are very drastic. There are expropriation, confiscation as well as domestication. Expropriation means seizure of foreign assets and compensating the owners for it (Li, 2009). Alternatively, expropriation means transfer of property involuntarily to the host country, which leads to generation of funds for the host country. However, getting compensation from the government takes a great deal of time, and the amount that they receive is often very low. Also, there are chances of conflicts if the compensations are not paid. For example, Cuba did not compensate the US firms after seizing their assets (Albertus & Menaldo, 2012).

The risk of confiscation is similar to expropriation excepting compensation. In this case, the property is transferred involuntarily and no compensations are paid (Wyman, 2007). Confiscation is representative of a more adverse situation.  It is a seizure of the assets of a company without compensation. For example, confiscation took place when Castro was elected as the leader of Cuba (Portes, 2007). The process of confiscation sometimes generates money for some businesses but the amount of money is very low and there is a prolonged process associated with it. Some industries face greater vulnerability to confiscation because they are of significant importance to the countries practicing confiscation and the fact that they are unable to shift operations. Mining, public utilities, banking and energy sectors have been the target sectors (Chang & Grabel, 2014).

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Domestication offers the government fair control over investments by foreign companies. It deals with the transfer of ownership partially and companies are asked to produce locally and retaining a huge profit share within the country (Pedro, 2016). The practice of domestication adversely affects the activities of the international business managers and also of the firm as a whole. If there were imposition of domestication within a short span of time, then the firm operations would be headed by poorly trained local managers who have no experience. This would increase the possibility of losses.

Other risks related to government actions are more common but are less dangerous. These include actions like boycott and sabotage (Huddy et al. 2005). Sometimes exchange controls are selectively applied against certain companies or some products. Such controls on exchange, impose a limit on the imports so that the firms face difficulty in their day-to-day transactions. The motive behind severe import restrictions was the shutting down of foreign companies. There are also chances of rise in tax rate being levied on foreign investors for controlling them and their capital.

Comparison of the Literature Review

Ostojić and Unković (2011) suggested that price control systems may be implemented by the government. Such controls derive from a delicate political environment. Arms conflict and insurrection which pose equal impact on all firms in the country are called macro political risks whereas strikes, nationalization and expropriation affect only specific firms are called micro political risks.

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Low levels of political environment in any country does not mean that the country has greater political freedom. Mark and Nwaiwu (2015) proposed that some authoritarian states are more stable than others. Assessing political risks on a long term basis should state that an oppressive political environment is stable only when there is maintenance of top-down controls. Under such circumstances, citizens are prevented from unpaid exchange of goods with the rest of the world. According to Kingsley, Bergh and Bonardi (2012), the two basic ways through which assessing political environment improves business performance worldwide are protection of existing world investments. Hahn, Doh and Bunyaratavej (2009) believed that constructing a systematic approach to manage political risk helps multinational companies to improve business performance. Thus, reviewing the studies made by different scholars is very important because it portrays how political risks of the home country affect the business performance and foreign direct investment of foreign countries and the USA.

The home country’s political and economic situations hold importance for the foreign direct investment decisions. The home country’s stage of economic development determines the level of direct investment in the USA. It has been found in some studies that the host country’s corruption level does not significantly affect foreign direct investment. Erkekoglu and Kilicarslan (2016) made a survey on 114 firms was conducted on their foreign marketing entrance. An investigation was done on company preference between full-control and shared control modes of entry. It was found from the investigation that foreign direct investments are also prevented by sovereign risks. These investigations put forward the fact that multinational companies do not make investigations in those host countries which have high levels of political risks.

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Buckley et al. (2007) performed a case study on the U.S., analyzing the effects that political risks of the home country might have on foreign direct investment. This study was performed during 1980-1991, this period emphasized on the significance of the political risk in the home country regarding the foreign direct investment of USA. A more commercial application of this literature review would be government intervention in the home country in order to efficiently manage the political environment reducing the political risks as much as possible. This would lead to higher business performance and foreign direct investment increasing the prosperity of the home country.

Conclusion

The findings show that there is significant effect of political risks business performances of multinational companies. Foreign direct investment on the other hand is important for the country’s development. The investors consider various factors when they make investment decisions of which political risk is an important factor. These factors attribute to party politics and results in war and threats of conflicts, increasing crimes and terrorism, bombing, kidnapping and others that discourage foreign investors to make investments in the home country. Multinational companies can reap benefits if they manage the political environment and the risks associated with it. This would effectively enable companies to build new sources of revenue through market access. Foreign direct investment is one of the major sources of economic growth and so, managing political risks provides better scope of development in the future.

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