Dealing with high-risk environments: Institutional-based tools to reduce political risk costs

Abstract

The international business (IB) literature on political risk mitigation has assigned explanatory preeminence to the organizational capabilities of multinational corporations (MNCs). The literature has assumed that political risk is avoidable for MNCs with specific political capabilities. We argue that political risk is inevitable. We posit that even if MNCs have political capabilities, host countries' political risk and its associated costs will not simply disappear. Extending the literature on political risk mitigation, we highlight the role of institutional-based tools in curbing political risk costs. Specifically, we posit that MNCs can reduce political risk costs through (i) international investment agreements, (ii) investment contracts with host governments, (iii) political risk insurance, and (iv) guarantees with binding enforcement mechanisms in unison with relying on political capabilities, thereby dampening the negative effect of uncontrollable host country political risk. We leverage the political-institutional approach to political risk and draw on relevant literature from law and IB to develop a framework to describe the conditions under which MNCs may use these institutional-based tools.