As discussed earlier, host governmental risks are those related to actions of host governments acting against the interests of investors but within the relevant legislative scheme (Rugman and Collinson, 2009). These risks are taxation restrictions, currency inconvertibility, import and/or export restrictions, contract repudiation, ownership and/or personnel restrictions, and expropriation and/or confiscation.
Taxation can be used to either restrict or encourage foreign direct investment (FDI) by increasing or decreasing corporate income tax (Waring and Glendon, 2001). Foreign investors clearly aim to avoid duplication of taxes in the host country and
47
subsequently when remitting the monies to a home country (Ling and Hoi, 2006; Brink, 2004). Glass and Saggi (2014) compared the competition between host countries in attracting foreign investments and the implications of tax policy co- ordination of those countries. Their study established that host countries can attract FDI by reducing tax on multinational firms.
Currency inconvertibility can be a governmental action if the host country suffers from lack of hard currency reserves (Al Khattab et al., 2007). Currency inconvertibility includes restriction on the repatriation of monies (both capital and revenue) and currency exchange. Blocks or delays in profit repatriation, which sometimes can reach years after the dividend date, erode the investment rate, especially in countries where the currency depreciates in value (Weigel, 1970). Empirical research by Hood and Nawaz (2004: 14), found that “currency or trade control” is one of the biggest potential risks for international businesses. Moreover, Pahud de Mortanges and Allers (1996) found that profit remittances and exchange controls are a serious concern in relation to the political environment.
Contract repudiation is a breach of contract by the host government. This reflects a lack of commitment by the host government (Straub, 2008). Moran (2001) considered this a significant risk as it is typically a termination of an existing investment without compensation. Firms with large assets are unsurprisingly more concerned about contract repudiation by a host government (Al Khattab et al., 2007). Pahud de Mortanges and Allers (1996) found that 39% of international firms experienced contract problems in relation to host governments in their international business.
Import and export restrictions are often considered the most important factor in foreign market selection (Rugman and Collinson, 2009). Import restrictions imposed
48
by a government typically aim to support domestic production against imported substitutes (Keillor et al., 2005). Import restrictions might affect an overseas investor’s ability to import materials like drugs, spare parts or chemical substances, which will have an immediate adverse effect on profits and sales (Keillor et al., 2005). For example, in the mid-1980s, foreign-car manufacturers in Mexico were required to use locally produced materials and parts, which amounted to 50% of the value of each vehicle (Alon et al., 2006) because of import restrictions. As for exports, a government might impose restrictions to protect domestic growth in industries and control ‘strategically important’ goods (Rice and Mahmoud, 1990). There is a view, however, that international firms may be less concerned about export restrictions as these will negatively affect the host country’s balance of trade, making it unlikely that a host government will deploy them (Rice and Mahmoud, 1990; Hashmi and Guvenli, 1992; Subramanian, 1993).
Ownership restrictions are sometimes used by a host government, when it “demands that a government entity, or local nationals, owns part of the affiliate” (Pahud de Mortanges and Allers, 1997, p.305). As Root (1998) indicates, uncertain actions of the host government that create ownership risk can limit or destroy investors’ control of affiliates. In addition, personnel restriction takes place when host governments force international firms to employ the domestic workforce regardless of qualifications and experience (Brink, 2004). The main objective of government typically is to increase local employment and engagement in managing foreign investments (Al Khattab et al., 2007). These kinds of restrictions can clearly affect international firms’ capacity to make strategic and competent decisions (Keillor et al., 2005).
49
Expropriation is the power of host governments to deprive foreign investors of the legitimate exploitation of their investment (Howell, 2001). Researchers such as Burmester (2000), Minor (2003) and Shapiro (2006) regard expropriation as a critical and extreme political risk for all international firms. Ramarmurti and Doh (2004) argue that expropriation (or nationalisation of foreign assets) is becoming very uncommon in developing countries, but does still happen. Examples include the effective expropriation of shares by the Bolivian government in 2006 when it demanded that foreign companies renegotiate their contracts. The government argued that the Bolivian constitution allowed for such expropriation if judged to be in the interest of ‘public need’ (Rosado de Sá Ribeiro, 2009). There was also the nationalisation of 51% of Spanish company Repsol’s shares in YPF by the Argentinean government in April 2012. This happened during a time of high inflation, alarming reduction in growth and an increase in capital outflow (Moreno et al., 2013). Typically, the level of expropriation risk is inversely proportional to the level of technology in the industry, i.e. high-technology industries have a lower expropriation risk than low technology industries (Wilkin, 2001). Moran (1998) explains this in terms of the host country’s need for new technology and accompanying skills. Although expropriation is considered a critical risk, some have found that managerial concerns are low in relation to this risk (e.g. Al Khattab et al., 2007). Hood and Nawaz (2004) similarly argue that expropriation is diminishing as a concern even in politically volatile regions. They suggest that host countries might be reluctant to use expropriation against international companies because of the adverse consequences for them, such as international economic isolation and the withdrawal of support from the World Bank and the International Monetary Fund (Hood and Nawaz, 2004).
50
Host governments attract foreign investments through promoting liberal and stable policies (Baek and Qian, 2011) and offering financial (Li, 2006) and tax incentives to foreign investors (Al Khataab et al., 2007; Baek and Qian, 2011). And their reputation is essential to attracting foreign investors while minimising their uncertainty. Consequently, host governments’ attempts to regulate businesses are decreasing (Hood and Nawaz, 2005) and this explains the findings of Al Khattab et al. (2007) who show that managers, overall, are becoming less concerned about the host governmental risk.