Policy Risk, Political Capabilities and International Investment Strategy: Evidence from the Global Electric Power Industry

Abstract

Whereas conventional wisdom holds that policy risk - the risk that a government will opportunistically alter policies to expropriate a firm's profits or assets - deters foreign direct investment (FDI), we argue that multinational firms vary in their response to host-country policy risk as the result of differences in organizational capabilities for assessing and managing such risk, which are shaped by the home-country policymaking environment. Specifically, we hypothesize that firms from home countries with weaker institutional constraints on policymakers, or more intense political rent-seeking as the result of redistributive pressures among different economic or ethnic groups, will be less sensitive to host-country policy risk in their international expansion strategies. Moreover, firms from home-country environments with sufficiently weak institutional constraints or sufficiently strong redistributive pressures will seek out riskier host countries for their international investments in order to leverage their political capabilities, which may serve a source of superior performance. We find support for our hypotheses in a statistical analysis of the FDI location choices of multinational firms in the electric power industry during the period 1990-1999, the industry's first decade of internationalization.

Keywords: political risk, policy risk, internationalization, foreign direct investment, institutional distance, infrastructure, electricity, FDI, location choice

JEL Classification: F23, M1, L19, O17, P16